Math 149 Problem Set (Assignment)
Math 149 Problem Set (Assignment)
MATHEMATICAL FINANCE
ASSIGNMENT
CHAPTER 8
8.) A borrower deposits $200 immediately for the guarantee to be able to borrow $1000 at the end of
one year. The borrower must repay the $1000 at the end of two years.
SOLUTION
(a) The equation of value is
200 1( + i)2 −1000 1( + i) +1000 = 0
(1+ i)2 −5 1( + i) + 5 = 0.
Now solving the quadratic, we obtain
√ √
1+= 𝑖5 2
(5)
= 5 ± 2.5
((−5)(2)) (−1)(41)
t= = .
This method then uses a loan of 1000 made at time t =1 repaid with 1200 at time t = 53. The equation
of value is 1000 1( + j)=1200 or j =.20 for 2/3 of a year.
14. SOLUTION
(a) The NPV of the “buy” option is
(
50,000 (1.01)−72 − 400,000+ 4000
a
72 .01 ) = 24,424.80−604,601.57 = −$580,177.
(b) The NPV of the “lease” option is −12,000a= −$613,805.
72 .01
(c) The “buy” option should be chosen since it is the least negative.
20.) A $100,000 loan is to be repaid by 30 equal payments at the end of each year. Interest on the loan
is at 8% effective. In addition to the annual payments, the borrower must pay an origination fee at the
time the loan is made. This fee is 2% of the loan but does not reduce the loan balance. When the second
payment is due, the borrower pays the remaining loan balance in full. Determine the yield to the lender
considering the origination fee and the early pay-off of the loan.
18. SOLUTION
The loan origination fee is .02 100,000( ) = 2000.
100,000
The mortgage payment is R = =8882.74.
a
30.08
2 107,046.64( )
=.91622 rejecting the negative root.
1
Finally, i = − =1 .0914, or 9.14%. v
There are 10× =4 40 payments on this loan. The quarterly interest rates are j2 j1 ==.03 and =.035.
a
The loan balance B12 =1000 28 .03 =18,764.12. The loan 4
balance after 12 more payments is
The loan balance B10 = 5329.64a 20.08 = 52,327.23. The amount of the “wraparound” mortgage is
a
20.10
25. SOLUTION
The total payments are 6 (50)+ 6 (75)= 750. Now, K = 750 −690 = 60, so that
60/750 =.08 of each payment is interest and .92 is principal. Therefore, principal payments are 46
for the first six months and 69 for the last 6 months. The 12 successive loan balances are:
690, 644, 598, 552, 506, 460, 414, 345, 276, 207, 138, 69
SOLUTION
Machine A: D = =100
SOLUTION
Machine 1:
For the first 20 years periodic charges are
MATHEMATICAL FINANCE
ASSIGNMENT
CHAPTER 9
4.) Rates that associate assets and liabilities This basis looks at related assets and liabilities in
determining the applicable rate and does not consider an asset or liability in isolation. This is an
important type of analysis and will be discussed further in Chapter 11.
SOLUTION
The question is asking for the summation of the “real” payments, which is and solving the quadratic we
obtain .0241, or 2.41%.
14.) An amount of $10,000 is deposited for 10 years in a mutual fund which is expected to earn 8%
effective and has an annual expense ratio of 2%. Assume half of the expenses can be invested at the end
of each year by the mutual fund company in another account at an annual rate of 9%. Calculate the
accumulated value in this other account at the end of 10 years.
SOLUTION
The expense invested in the other account in year k is
⎤
⎡(1.09)10 −(1.06)10
=100⎢ ⎥ = $1921.73
.09−.06 ⎦
by a direct application of formula (4.34).
18.) A company has a asset with a depreciation basis of $100,000 which will be depreciated according to
the following schedule:
Year Percent
1 33.33
2 44.45
3 14.81
4 7.41
The depreciation charge at the end of each year is tax deductible. The marginal tax rate is 35% and the
pretax borrowing rate is 12%. Calculate the present value of the tax deductions created by the
depreciation schedule. Answer to the nearest dollar.
SOLUTION
The tax deduction is 35% of the depreciation charge.
Year Depreciation charge Tax deduction
1 33,330 11,666
2 44,450 15,558 3 14,810
5,184
4 7,410 2,594
+ 2
+ 3
+ 4
= $30,267 to the nearest dollar.
𝐶0 𝐶1 𝐶2 𝐶3 𝐶4 𝐶5
-80 10 20 23 27 25
The current exchange rate is $1.2 = €1. The interest rate in the U.S. is 8% and the euro interest rate is
6%.
a) Calculate the NPV of the euro cash flows.
b) What are the dollar cash flows from the project?
c) Calculate the NPV of the dollar cash flows.
9.8 Reflecting risk and uncertainty
SOLUTION
(a) NPV =− +80 10 1.06( )−1 + 20 1.06( )−2 + 23 1.06( )−3 + 27 1.06( )−4 + 25 1.06( )−5 = €6.61 million.
(b) The expected exchange rate expressed in dollars per €1 (not in euros per $1) at
1.08 ee e
1.223. The cash flow at time t =1 in dollars then
time t =1 is = and e = 1.06 1.2
is
ee 1.2 1.223 1.246 1.269 1.293 1.318 $ million -96 12.23 24.91
29.19 34.92 32.94
SOLUTION
(a) Assume that the borrower will prepay if the interest rate falls to 6%, but not if it rises to 10%. The
expected accumulated to the mortgage company is
(b) Var =.5 1,144,800( −1,161,400)2 +.5 1,178,000( −1,161,400)2 = 275,560,000 and
(d) We have 1,161,400 =1,000,000 1( + i)2 which solves for i =.0777, or 7.77%.
(e) The option for prepayment by the borrower has a value which reduces the expected yield
rate of 8% that the lender could obtain in the absence of this option.