ActSc 231

Oct 14 and Oct 16 2015

Examples
1. Mr. Haywood deposits $100 in a fund on Jan 1. On Mar 1, the account balance is $102 and then
$50 is withdrawn. The account balance becomes $52.5 on May 1 and Mr. Haywood deposits $50. At
the end of year Mr. Haywoods fund balance is $111. Find the approximate dollar-weighted yield and
the time-weighted yield.
Sol: The opening balance is A = 100, the closing balance is B = 111. The contribution at t1 =
4
Ct1 = 50, at t2 = 12
is Ct2 = 50. Therefore the approximate dollar-weighted yield is
idw

2
12

is

B A Ct1 Ct2
111 100 (50) 50
= 12%
=
2
4
A + Ct1 (1 t1 ) + Ct2 (1 t2 )
100 50(1 12
) + 50(1 12
)

Note that the IRR (dollar-weighted yield) is 12.0309%. Please verify!

The accumulation factor for the first 2 months is
1 + i1 =
for the next 2 months is

102
Bt1
=
= 1.02,
A
100

1 + i2 =

Bt2
52.5
= 1.0096,
=
Bt1 + Ct1
102 50

1 + i3 =

B
111
=
= 1.0829.
Bt2 + Ct2
52.5 + 50

from May 1 to year end is

Therefore the time-weighted yield is

itw = (1 + i1 )(1 + i2 )(1 + i3 ) 1 =

102 52.5
111
= 1.02 1.0096 1.0829 1 = 11.52%
100 102 50 52.5 + 50

2. An investment account is opened with a deposit of $10,000. One month later the balance is $9500
and then $2000 is deposited. At the end of 8 months the balance is $13,000 and then $4000 is withdrawn. The balance at the end of the year is $10,000. Find the approximate dollar-weighted yield
and the time-weighted yield.
Sol:
A = B = 10000, Ct1 = 2000, t1 =
idw

1
12 , Ct2

= 4000, t2 =

8
12 .

The approximate dollar-weighted yield is

10000 10000 2000 + 4000

1
10000 + 2000(1 12
) 4000(1

8
12 )

= 19.05%.

The time-weighted yield is

itw =

13000
10000
9500
1 = 19.32%.
10000 9500 + 2000 13000 4000

3. Mohammed had $20,000 in his investment account on August 15, 1999. On August 15, 2000 his
balance was $21,200 and he deposited an additional $5000, giving him a new balance of $26,200.
On August 15, 2001, Mohammeds account had a balance of $27,300. Assuming that there are no
other contributions to the account, find the annual dollar-weighted yield, annual approximate dollarweighted yield and annual time-weighted yield.
Sol:
The present value equation is
20000 5000(1 + idw )1 + 27300(1 + idw )2 = 0,
or equivalently the future value equation is
20000(1 + idw )2 5000(1 + idw ) + 27300 = 0.
Therefore the annual dollar-weighted yield is idw = 5%.
The approximate dollar-weighted yield for TWO years is
27300 20000 5000
= 10.22%.
20000 + 5000(1 21 )
Therefore the annual approximate dollar-weighted yield is
p
idw 1 + 10.22% 1 = 4.9868%.
The annual time-weighted yield is
r
itw =

21200 27300
1 = 5.0954%.
20000 26200

4. A person deposits $1000 on January 1, 1997. Find the AV on January 1, 2000. Using the investment
year method, the portfolio yield method and assuming the balance is withdrawn at the end of each
year and reinvested at the new rate.
Year of original investment
y
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001

Investment
iy1
iy2
8.25
8.25
8.50
8.70
9.00
9.00
9.00
9.10
9.25
9.35
9.50
9.50
10.00 10.00
10.00 9.80
9.50
9.50
9.00

year rates(%)
iy3
iy4
iy5
8.40 8.50 8.50
8.75 8.90 9.00
9.10 9.10 9.20
9.20 9.30 9.40
9.50 9.55 9.60
9.60 9.70 9.70
9.90 9.80
9.70

Portfolio rates(%)
iy+5
8.50
8.60
8.85
9.10
8.35

Sol:
Investment year method:
1000(1 + i1997
)(1 + i1997
)(1 + i1997
) = 1000 1.095 1.095 1.096 = 1314.13
1
2
3
Portfolio method:
1000(1 + i1997 )(1 + i1998 )(1 + i1999 ) = 1000 1.0835 1.086 1.0885 = 1280.82
Withdraw and reinvest each year:
1000(1 + i1997
)(1 + i1998
)(1 + i1999
) = 1000 1.095 1.10 1.10 = 1324.95
1
1
1
5. Ashley doposits $500 into a fund each January 1, starting in 2005 and continuing to 2014 inclusive.
If the fund earns an annual effective rate of 10%, how much will be in her account on January 1, 2019?
Sol:
Let January 1, 2004 be time 0. At t = 10 the fund value is 500s10|10% . At t = 15 the fund value is
500s10|10% (1 + 10%)5 = 500

1.110 1 5
1.1 = 12833.69.
0.1

6. (a) Barbara wants to accumulate $10,000 by the end of 10 years. She starts making quarterly
deposits in her investment account, which pays i(4) = 8%. Determine the size of these deposits.
(b) Suppose after 4 years, the rate of return changes to i(4) = 6%. Determine the size of the quarterly
deposits now required if the $10,000 goal is to be met.
Sol:
(a) The quarterly effective rate of interest is
the size of the quarterly deposits be R, then

i(4)
4

= 2%. There are 4 10 = 40 deposits in total. Let

Rs40|2% = 10000
R=

10000
s40|2%

10000 0.02
1.0240 1
= 165.56
=

(b) The quarterly effective rate after year 4 is 1.5%. The AV of the first 16 deposits at the end of year
4 is Rs16|2% , at the end of year 10 is Rs16|2% (1.015)24 . Let the size of the quarterly deposits after
year 4 be R0 , then
Rs16|2% (1.015)24 + R0 s24|1.5% = 10000
R0 =

10000 Rs16|2% (1.015)24

s24|1.5%
16

1
24
10000 165.56 1.02
0.02 1.015
1.01524 1
0.015

= 195.18

7. Maria receives an inheritance of $25,000 on May 14, 2010. If she invests the money in a fund paying
7% p.a. compounded quarterly, how much can she withdraw every 3 months if the first withdrawal is
August 14, 2010, and the final withdrawal is August 14, 2025?
Sol:
The quarterly effective interest rate is 1.75%. There are 61 withdrawals. Let the amount of withdrawal
be R, then
25000 = Ra61|1.75%
R=
=

25000
a61|1.75%
25000
1(1+0.0175)61
0.0175

= 670.04

8. A used car is purchased for $2000 down and $200 a month for 6 years. Interest is at i(12) = 10%.
(a) Determine the price of the car.
(b) If the first 4 monthly payments are missed, what payment at the time of the 5th payment will
update the payments?
(c) Assuming no payments are missed, what single payment at the end of 2 years will completely pay
off the debt?
(d) After 27 payments have been made, the contract is sold to a buyer who wishes to yield i(12) = 12%.
Determine the sale price.
Sol:
(a) The price equals the PV of all payments:
2000 + 200a72|0.833% = 2000 + 200

1 (1 + 0.00833)72
= 12795.73
0.00833

(b) This will be the AV of the first 4 payments plus the 5th:
1.0083372 1
= 1016.81
0.00833

200s5|0.833% = 200

(c) This will be the value at the end of year 2 of all future payments plus the payment due at the end
of year 2:
1 (1 + 0.00833)48
200 + 200a48|0.833% = 200 + 200
= 8085.63
0.00833
(d) There are 45 payments to be made. The price should be the discounted value of those payments
under monthly effective rate of interest of 1%:
200a45|1% = 200

1 1.0145
= 7218.90
0.01

9. Hyun wishes to contribute $100 at the end of each month to his savings account until the account
has a balance of at least $3000, at which time he will buy his grandmothers piano. Hyuns savings
account has an annual interest rate of 5.4% convertible monthly. How many months it will take Hyun
to accumulate the needed money, and how much money will he then have saved?
Sol:
The monthly interest rate is 0.45%. We want to find the smallest integer n such that 100sn|0.45%
3000. We then have the following equivalent inequalities:
100

1.0045n 1
3000
0.0045
n
1.0045 30 0.0045 + 1
n ln 1.0045 0.126632651
n 28.2039

So n = 29, and Hyuns balance is

100s29|0.45% = 100

1.004529 1
= 3090.32.
0.0045

Exercises
1. Abiyote invested $24,500 on January 1, 1994 in the Utopia Fund. On May 1, 1995, his balance was
$28,212 and he withdrew $10,000. On December 1, 1995, his balance was $15,892, and he deposited
$8,000. On January 1, 1997 his balance was $30,309. Find the approximate annual dollar-weighted
yield and the annual time-weighted yield for the three-year period from January 1, 1994 until January
1, 1997.
Sol:
A = 24500, B = 30309, Bt1 = 28212, Ct1 = 10000, t1 =

16
36 , Bt2

= 15892, Ct2 = 8000, t2 =

23
36 .

The approximate dollar-weighted yield for the three-year period is

30309 24500 + 10000 8000
16
) + 8000(1
24500 10000(1 36

23
36 )

= 0.357664122,

hence the approximate annual dollar-weighted yield is

idw 3 1 + 0.357664122 1 = 10.7297%.

The annual time-weighted yield is
r
28212
15892
30309
itw = 3
1 = 8.4266%.
24500 28212 10000 15892 + 8000
2. Derartu deposits $3000 in the fund at the beginning of 1965 and leaves it on deposit through 1968.
Find the AV of the fund balance at the end of 1968. Using the investment year method, the portfolio
yield method and assuming the balance is withdrawn at the end of each year and reinvested at the
new rate.
Year of original investment
y
1965
1966
1967
1968

Investment year rates(%)

iy1
iy2
iy3
iy4
5.00 5.50 4.75 5.00
6.00 5.25 5.00 6.00
5.00 5.00 6.25 6.00
6.75 7.00 7.00 6.75

Portfolio rates(%)
iy
5.50
5.75
6.25
6.15

Sol:
Investment year method:
1000(1 + i1965
)(1 + i1965
)(1 + i1965
)(1 + i1965
) = 3000 1.05 1.055 1.0475 1.05 = 3655.16
1
2
3
4
Portfolio method:
1000(1 + i1965 )(1 + i1966 )(1 + i1967 )(1 + i1968 ) = 3000 1.055 1.0575 1.0625 1.0615 = 3774.88
Withdraw and reinvest each year:
1000(1 + i1965
)(1 + i1966
)(1 + i1967
)(1 + i1968
) = 3000 1.05 1.06 1.05 1.0675 = 3742.60
1
1
1
1

3. Tracy receives payments of $X at the end of each year for n years. The present value of her annuity
is $493. Gary receives payments of $3X at the end of each year for 2n years. The present value of his
annuity is $2,748. Both present values are calculated at the same annual effective interest rate. Find
vn .
Sol:
When v 6= 1, we have the following two equations:
1 vn
= 493
i
1 v 2n
= 3X
= 2748
i

Xan|i = X
3Xan|i

Divide the first equation by the second, we have

493
1 1 vn
=
,
3 1 (v n )2
2748
which implies
0.5382(v n )2 v n + 0.4618 = 0.
Therefore v n = 0.858012. Note that the other root v n = 1 should not be taken since we have assumed
v 6= 1. If v = 1, then Xn = 493 and (3X)(2n) = 2748. No solution exists.

4. Mrs. Williams finds that she has two options for investing $32,000.02 for fifteen years. The
first option is to deposit the $32,000.02 into a fund earning a nominal rate of discount d(4) payable
quarterly. The second option is to purchase an annuity-immediate with 15 level annual payments,
the annuity payments computed using an annual effective rate of 7%, and then when she gets an
annuity payment, she immediately invest it into a fund earning an annual effective rate of 5%. Mrs.
Williams calculates that the second option produces an accumulated value that is $1,500 more than
the accumulated value yielded by the first option. Calculate d(4) .
Sol:
Let the level annual payment be $X, then Xa15|7% = 32000.02. Since all payments are reinvested
with 5% interest rate, the accumulated value of these 15 payments is
Xs15|5% = 32000.02

s15|5%
a15|7%

This is the AV under the second option. The AV under the first option is

415
d(4)
32000.02 1
.
4
The second option being better off by $1,500 implies
32000.02

s15|5%
a15|7%


415
d(4)
= 32000.02 1
+ 1500.
4

The annuity values are s15|5% = 21.5786 and a15|7% = 9.1079, hence d(4) = 5.5779%.

5. Suppose the AV of a fifteen-year annuity-immediate is $37,804.39 and its PV is $15077.10. Both

AV and PV are calculated at the same interest rate. Determine the amount of annual payment and
the annual effective interest rate.
Sol:
Let the amount of annual payment be X and the annual effective interest rate be i 6= 0, then
(1 + i)15 1
= 37804.39
i
1 (1 + i)15
=X
= 15077.10
i

Xs15|i = X
Xa15|i

Divide the first equation by the second and put y = (1 + i)15 , we have
y 2 3.5074y + 2.5074 = 0.
Hence y = 2.5074 i = 6.32% X = 1585.00. If i = 0, then AV=PV which is not the case.