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Week 2 - Tutorial Questions

The document contains tutorial exercises for a financial mathematics course, focusing on various investment scenarios and interest calculations. It includes questions on simple and compound interest, present value, and accumulated value under different rates and time periods. Additionally, it features a past exam question related to compound interest growth over time.

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8 views2 pages

Week 2 - Tutorial Questions

The document contains tutorial exercises for a financial mathematics course, focusing on various investment scenarios and interest calculations. It includes questions on simple and compound interest, present value, and accumulated value under different rates and time periods. Additionally, it features a past exam question related to compound interest growth over time.

Uploaded by

qq1812016515
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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TUTORIAL EXERCISES WEEK 2

Question 1
$2,500 is invested. Find the accumulated value of the investment 10 years after it is made for
each of the following rates.
(a) 4% annual simple interest
(b) 4% effective annual compound interest
(c) 2% effective 6-month compound interest
(d) 1% effective 3-month compound interest

(e) In Excel, calculate the accumulated value of $100 under each of the following situations /
scenarios (note: Do use Excel to do these calculations, as most subsequent tutorials will
have additional Excel-based work – best to practice and start using Excel as soon as you
can)

Annual effective interest rate, i


Years invested -2% 0% 2% 4% 6% 10%
2
5
10
20
30

Question 2
If the effective 3-month compound interest rate is -3%, what is the accumulated value after 1
year of an initial investment of $1?

Question 3
It is known that the present value of $864 due in two years is $600. Find the accumulated
value of $2000 invested at the same rate of compound interest for three years.

Question 4
What is the present value of $1000 due in 10 years if the effective annual interest rate is 6%
for each of the first 3 years, 7% for the next 4 years, and 9% for the final 3 years?

Question 5
Smith needs to borrow $5,000 for one year.

Under one scenario (A) he is offered a loan at an effective annual rate of 5%. In other words,
he has to pay interest of 5, 000  0.05  250 at the end of the year.

Under another scenario (B) , he is offered a loan of $10,000 at a lower effective annual rate of
interest denoted by i . If he borrows the $10,000, he can invest the excess $5,000 for one year

STAT2032/6046 – Financial Mathematics 1


at 3%. In other words, at the end of the year he will have to pay interest of (10, 000  i ) , but
he receives interest of 5000  0.03  150 .

How low must the rate on the $10,000 loan (scenario B) be in order for Smith to prefer it to
the $5,000 loan (scenario A)?

Question 6
Jones invests $100,000 in a 180-day short term investment at a bank, based on simple interest
at an annual rate of 7.5%. After 120 days, interest rates have risen to 9% and Jones would
like to redeem the certificate early and reinvest in a 60-day certificate at the higher rate.

In order for there to be no advantage in redeeming early and reinvesting at the higher rate,
what early redemption penalty P should the bank charge at the time of early redemption?

Hint: You can approach this question by equating the accumulated value of two scenarios and
solving for P .
A) Jones invests $100,000 for 180 days at 7.5% simple interest per annum.
B) Jones invests $100,000 for 120 days at 7.5% simple interest per annum and then
redeems the accumulated amount. Upon redemption he pays a penalty of P . He then
reinvests the balance at 9% simple interest per annum for 60 days.

Question 7
(a) Show that for an effective annual compound interest rate of i , the amount of interest
earned in successive years on an investment of $1 grows by a factor of (1  i ) and these
amounts are i , (1  i)i , (1  i ) 2 i , …, (1  i ) n 1 i for the first, second, third, …, nth year,
respectively.
(b) Using the fact that the amount of interest earned from time 0 to time n is (1  i ) n  1 ,
derive a formula for the sum 1  (1  i )  (1  i ) 2  ...  (1  i ) n 1 .

Past Exam Question – 2005 Final Exam Q1(d)


At a certain rate of compound interest, 1 will increase to 2 in a years, and 4 will increase to
20 in b years. If 6 will increase to 15 in n years, show that n = b - a. (3 marks)

STAT2032/6046 – Financial Mathematics 2

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