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MS216

An Introduction to the Mathematics of Finance Tutorial Sheet Interest Rate Calculations

1.1 The eective annual rate of interest on a savings account is currently 4 1 % but, in 5 years time, it 2 will fall to 3 1 % per annum. Find the accumulation of e10,000 in 10 years time. 2 1.2 How much should be deposited today in a savings account paying 4 1 % per aannum to receive 2 1 e4,000 in 4 years time? What would be the amount required at a rate of discount of 4 2 % per annum eective? 1.3 Find the value today and in 10 years time of payments of e5,000 at the end of 5 years and e10,000 at the end of 10 years at a rate of interest of 5 1 % per annum eective. 4 1.4 A savings institution oers guaranteed nominal rates of: (1) 4 1 % per annum convertible monthly. 2 (2) 4 3 % per annum convertible quarterly. 4 (3) 4 7 % per annum convertible half-yearly. 8 (4) 5% per annum eective. Which option oers the best eective rate to an investor with e5,000 to deposit for one year? 1.5 Determine the accumulated value of e1,500 at the end of 2 years on the basis of: (a) a nominal annual rate of interest of 4 1 % convertible quarterly. 2 (b) a nominal annual rate of discount of 4 1 % convertible quarterly. 2 (c) a force of interest of 4 1 %. 2 (d) a nominal annual rate of interest of 4 1 % convertible monthly for the rst year, followed by a 2 nominal annual rate of discount of 4 1 % convertible quarterly in the second year. 2 1.6 Credit instutution A is oering a nominal rate of interest of 4 1 % per annum convertible quarterly 2 on xed-term deposits of 10 years. Competitor instutution B is quoting a nominal rate of discount per annum convertible monthly also on xed-term deposits of 10 years with a guarantee to investors that the accumulated amount in accounts after 10 years will be 5% greater that of institution A for the same initial deposit. Calculate the quoted nominal rate of discount per annum convertible monthly. 1.7 The accumulation of e6,000 after 6.25 years, on the basis of a nominal interest rate of 3 3 % per 4 annum convertible monthly, has the same value as an accumulation of e5,000 after 8.25 years on the basis of a constant force interest . Find the value of . 1.8 Consider the following: (a) In return for a loan of e500, a borrower agrees to repay e520 after 6 months. Find: (i) (ii) (iii) (iv) the the the the eective rate of interest per annum; nominal rate of interest per annum convertible monthly; eective rate of discount per annum; and force of interest per annum for the transaction.

(b) Shortly after receiving the loan, the borrower proposes to repay half the loan amount (i.e. e250 on the original settlement date and a second payment 5 months after this date. Assuming that the borrower agrees to the request and that the calculation is made on the original interest basis, nd the amount of the second payment under the revised transaction. 1

1.9 A loan of e500 is to be repaid in two instalments, payable in 6 and 11 months time respectively. If the rst repayment is e250, nd the amount of the second repayment on the basis of an interest rate of 8% per annum eective. 1.10 A student has incurred the following debts: e2,400 on 1 October 2007, e3,600 on 1 October 2008 and e1,200 on 1 April 2009. Calculate the net value of these debts on: (a) 1 October 2005; (b) 1 December 2006; assuming a rate of interest of 7 1 % per annum eective. 2 1.11 In return for payments of e2,400 at the end of January, March and May, and payments of e3,600 at the end of July, September and November, an investor agrees to pay the total value of the 6 payments on January 1, and to either make or receive an additional payment on December 31. Find the amount of that additional payment on the basis of a nominal annual interest rate of 7 1 % 2 per annum convertible monthly. 1.12 On 1 January 2008, an equity broker was advised that she will be required to settle three outstanding trading debts at nominated dates in the future: e10,000 on 1 January 2010, e25,000 on 1 January 2015 and e15,000 on 1 January 2017. As part of a review of her future commitments, the broker now oers either: (a) To discharge her liability for the three debts by making an appropriate single payment on 1 January 2012; or (b) To repay the total amount owed (i.e. e50,000 in a single payment at an appropriate future date. Assuming a rate of interest of 7 1 % per annum eective, nd the appropriate single payment if oer 4 (a) is accepted by the creditor, and the appropriate time to repay the entire indebtedness if oer (b) is accepted by the creditor. 1.13 At what constant force of interest would a payment of e6,400 today be the same as the present values of e3,000 in 3 years time and e6,000 in 6 years time? 1.14 A loan of e750 is to be repaid by two equal repayments of e500, the rst in 3 years time and the second in 5 years time. Calculate the eective annual interest rate implied by this transacton. 1.15 An overdue utility bill of e1,700 is to be settled by making repayments of e500 in 3 months time, e600 in 7 months time and e700 in 11 months time. Calculate the eective annual interest rate implied by this transacton.

MS216

An Introduction to the Mathematics of Finance Tutorial Sheet Basic Compound Interest Functions

2.1 Calculate: (a) a10 (b) a8 (c) s5 (d) s16

using a rate of interest of 4 3 %. 4 2.2 A sum of e300.24 is paid into a loan account at the end of every month for 5 years. Calculate the present value of the payments if interest is calculated on the basis of 7 1 % per annum convertible 2 quarterly. 2.3 A sum of e315 is lodged into a deposit account at the start of every month for 5 years. Calculate the accumulation in the account if interest is calculated on the basis of 3 7 % per annum eective. 8 If the total interest earned is taxed at a rate of 20%, calculate the net value of the account after 5 years. 2.4 Find the present value as at 1 September 2006 of 35 monthly payments each of e875 commencing on 1 June 2001, assuming a rate of interest of 7 3 % per annum convertible quarterly. 4 2.5 A person aged 22 today is going to make level annual deposits, starting one year from now, into a savings account paying interest at a rate of 4% per annum eective. Calculate: (a) The amount of money which will accumulate on her 65-th birthday. if e1,200 is deposited each year. (b) The annual deposit which should be made to provide a sum of e500,000 on her 65-th birthday. 2.6 A car loan is repayable by an annuity payable monthly in arrears for 10 years. The amount of the repayment increases by e25 after 4 years and by a further e25 after 7 years, and is calculated on the basis of a nominal rate of interest of 7 3 % per annum convertible quarterly. Calculate the value 4 of the loan if the initial monthly repayment was e221.23. 2.7 Let e25,000 be invested in an account at the present time. In return for this initial investment, the investor receives either: (1) e35,900 in 5 years time, or (2) e50,300 in 10 years time, or (3) A series of 5 annual payments of e5,800 each, the rst such payment being made today. (3) A series of 5 annual payments of e8,600 each, the rst such payment being made after 5 years. Rank the alternatives on the basis of their respective yields, with the alternative having the highest yield ranked rst and so on. 2.8 A borrower agrees to make the rst in a series of 5 payments of e1,200 in 3 years time. These instalments fully repay a loan of e4,200, which the borrower has just received. Find the yield per annum on this transaction. 2.9 At the beginning of each year for 10 years, e4,800 is deposited in a savings account which pays a certain xed rate of interest per annum. At the time of the last payment, the proceeds of the account are used to purchase a level annuity payable annually in arrears for 15 years at the same xed rate of interest as that paid on the savings account. If the annuity instalment is e5,500, nd the rate of interest payable on the savings account. 1

2.10 Given an eective annual rate of interest of 5%, what is the present value of a perpetuity of e2,000 per annum: (a) immediately before a payment; (b) immediately after a payment. 2.11 Calculate: (a) (Ia)10 (b)
3

a8

(c)

a5

(d)

s16

using a rate of interest of 4 3 %. 4 2.12 A loan is to be repaid by an annuity, payable annually in arrears. The repayments start at a rate of e1,200 per annum and increase by e100 per annum. The annuity is paid for 10 years. Repayments are calculated using a rate of interest of 3 1 % per annum eective. Calculate the amount of the 2 loan. 2.13 An annuity is payable annually in arrear for 15 years. The rst payment is of amount e1,500 and the amount of each subsequent payment decreases by e100 each year. Find the present value of the annuity on the basis of an interest rate of 8 1 % per annum. 8 2.14 In return for a single premium of e50,000, an investor will receive an annuity payable annually in arrears for 10 years. The annuity payments increase from year to year at the (compound) rate of 4 1 % per annum. Given that the initial amount of the annuity is determined on the basis of an 2 interest rate of 7 1 % per annum, nd the amount of the rst payment. 4 2.15 A married couple borrowed e200,000 over 20 years from a lending institution charging interest 1 at 5 4 % per annum convertible monthly. The couple decided to repay the loan in xed monthly repayments during each year but to increase the monthly repayments by 5% on an annual basis. Calculate the monthly repayment for the rst and nal years. 2.16 A continuous payment stream is such that the level rate of payment in year t is 100(1 + g)t1 for t = 1, 2, . . . , 20 and where g = 4 1 % Calculate the present value of the payment streams at its 2 commencement date, assuming a rate of interest of 7 1 % per annum convertible monthly. 4 2.17 Suppose that a borrower is to repay a loan by 20 equal instalments, payable annually in arrear at a rate of interest of 6% per annum. If, at the outset, the borrower is oered a choice between: (1) a 1% reduction of the loan; or (2) a 1% reduction in the interest rate, which should be chosen so as to minimise the annual repayment? 2.18 Find the accumulated value as at 1 July 2006 of a series of payments of e640 paid every 3 years 1 from 1 July 1978 to 1 July 2005 inclusive, which accumulate at 8 8 % per annum convertible monthly.

MS216

An Introduction to the Mathematics of Finance Tutorial Sheet Loans/Annuities Payable p-thly

3.1 A loan of e250,000 is to be repaid by a level annuity payable annually in arrears for 25 years, calculated at an eective rate of interest of 7% p.a. (a) i. ii. iii. iv. Find the annual repayment. Find the capital and interest components of the fth payment. After which repayment is there less than e50,000 outstanding on the loan? For which repayment does the capital content rst exceed the interest content?

(b) Immediately after making the twentieth payment, the borrower requests that the loan be extended by 5 years. Given that the lender accedes to this request, nd the revised annual repayment for the remaining period of the loan. 3.2 A loan of e9,880 was granted on 10 July 1978. The loan is repayable by a level annuity payable monthly in arrears (on the 10th of each month) for 25 years and calculated on the basis of an interest rate of 7% per annum eective. Find (a) the monthly repayment; (b) the loan outstanding immediately after the repayment on 10 March 1992; (c) the capital to be repaid on October 1989; (d) (i) the total capital to be repaid, and (ii) the total amount of interest to be paid, in the monthly instalments due between 10 April 1996 and 10 March 1997 (both dates inclusive). (e) the month when the capital to be repaid rst exceeds one-half of the interest payment.
Source: Exercise 4.12 J J McCutcheon & W F Scott

3.3 An insurance company issues an annuity of e10,000 per annum payable monthly in arrear for 20 years. The cost of the annuity is calculated using an eective rate of interest of 10% per annum. (a) Calculate the interest component of the rst instalment of the sixth year of the annuity. (b) Calculate the total interest paid in the rst 5 years. 3.4 A loan of e2,000 is to be repaid by a level annuity, payable annually in arrears for 18 years. The interest rate is 10% per annum for the rst 6 years and 9% per annum thereafter. (a) What is the annual repayment? (b) Calculate the capital outstanding immediately after the 6th payment has been made. (c) Immediately after the 12th payment, the borrower makes an additional payment of e100. The interest basis remains the same. By how much should the remaining payments be reduced to ensure that the term of the loan remains the same? 3.5 A loan of e11,820 was repayable by an annuity payable quarterly in arrears for 15 years. The repayment terms provided that at the end of each ve-year period the amount of the quarterly repayment would be increased by e40. The amount of the annuity was calculated on the basis of an eective rate of interest of 12% per annum. (a) Find the initial amount of the quarterly repayment.

(b) On the basis of the lenders original schedule nd the amount of principal repaid in (i) the third year and (ii) the thirteenth year: (c) Immediately after paying the 33rd quarterly instalment the borrower requested that in future the repayments be of a xed amount for the entire outstanding duration of the loan. The request was granted and the revised quarterly repayment was calculated on the original interest basis. Find the amount of the revised quarterly repayment:
Source: Exercise 4.14 J J McCutcheon & W F Scott

3.6 A loan is repayable by an increasing annuity payable annually in arrears for 10 years. The repayment at the end of the rst year is e1,000 and subsequent payments increase by e100 each year. The repayments were calculated using a rate of interest of 8% per annum eective. (a) Calculate the original amount of the loan. (b) Calculate the capital outstanding at the beginning of the 7-th year (i.e. immediately after the 6-th payment of interest and capital). (c) Immediately after making the 6-th payment of interest and capital, the interest rate on the outstanding loan is increased to 8 1 % per annum eective. Calculate the amount of the 7-th 2 payment if subsequent payments continue to increase by e100 each year and the loan is to be repaid by the original date, i.e. 10 years from the start of the loan. 3.7 An annuity is payable in arrears for 15 years. The annuity is payable half-yearly for the rst ve years, quarterly for the next ve years, and monthly for the nal ve years. The annual amount of the annuity is doubled after each ve-year period. On the basis of an interest rate of 8% per annum convertible quarterly for the rst four years, 8% per annum convertible half-yearly for the next eight years, and 8% per annum eective for the nal three years, the present value of the annuity is e2049. Find the initial annual amount of the annuity. (The value of i/i(6) at 4% is 1.016540.)
Source: Exercise 4.7 J J McCutcheon & W F Scott

3.8 Calculate the APR applicable on a loan of e10,000, repayable by instalments of e6,000 repayable after two and four years. 3.9 A car loan is to be repaid over 3 years by monthly instalments of e400 made in arrears. If the cash price of the car is e10,200, calculate the APR on the transaction. 3.10 An advertisement in the Irish press on Monday, 16 February 2004, carried the following details relating to the sale of the latest version of the Omega 1.2 Stella motor car: List Price e15,580 Number of Repayments 36 Documentation Fee e72 Deposit e3,678.44 Monthly Repayment e216.61 Total Amount Repayable e18,048.36 Finance Amount e11,901.56 Final Instalment e6,499.96

where it is assumed that the 36 monthly repayments are made in arrears, that the deposit and documentation fee is paid at the time of purchase, and that the nal instalment is made at the end of the 3 years, i.e. at the time of the nal monthly repayment and is additional to that repayment amount. Calculate the APR implied by this transaction.

MS216

An Introduction to the Mathematics of Finance Tutorial Sheet Project Appraisal

4.1 A company is considering two capital investment projects. Project A requires an immediate expenditure of e1, 000, 000 and will produce returns of e270, 000 at the end of each of the next eight years. Project B requires an immediate investment of e1, 200, 000 together with further expenditure of e20, 000 at the end of each of the rst three years, and will produce returns of e1, 350, 000 at the end of each of the sixth, seventh and eight years. (a) Calculate (to the nearest 0.1%) the internal rate of return per annum for each project: (b) Find the net present value of each project on the basis of an eective annual interest rate of 15%:
Source: Exercise 5.1 J J McCutcheon & W F Scott

4.2 An investment compnay is considering the purchase of an newly-built apartment complex: The purchase price is e5m and the company has been advised that a further e0.5m will be required in 6 months time to cover the cost of ttings and furniture. Due to high demand, there is a ready supply of potential tenants; and occupancy would commence 1 year after the date of purchase of the building. The company plans to collect rent for 5 years and will then sell the building for e5.9m. The initial annual rental income will be e0.4m per annum and this will be increased by the same percentage compound at the beginning of each successive year. Assuming that rental income is received quarterly in advance, and that the compound percentage increase in the annual rent is 3%, calculate the net present value of the project using an interest rate of 7 1 % per annum. 2 4.3 A car-hire company purchases cars from a manufacturer and immediately rents them out to clients on 4-year contracts. The current purchase price of each car is e10,500 and the company expects that the sale price of each car at the end of the 4-year contract will be e4,500. The rental income is payable continuously throughout the 4-year period and increases by e480 at the end of each year. Calculate the initial annual rent which the car-hire company must charge in order to achieve an internal rate of return of 15% per annum. 4.4 An internet company is considering whether or not to purchase an additional high-speed workstation. It has been estimated that the extra machine would produce an income of e(6, 000 + 400t) in years t = 1 to t = 5 and that the machine would have no value after 5 years. It is assumed that the income receipts arise in the middle of each year. If the purchase price of the workstation is e22,000, calculate the internal rate of return on the investment. 4.5 An Irish food company is considering opening a sales and distribution store in France for a limited 20-year period. The initial cost of the outlet would be e2.5m incurred at the outset of the project. It is expected that rents of e120k per annum would have to be paid quarterly in advance for 10 years, increasing after 10 years to e150k per annum. The net revenue (sales minus costs, other than rent) from the venture is expected to be e200k for the rst year and e300k for the second year. Thereafter, the net revenue is expected to grow at 5% per annum compound so that it is e315.00k in the third year, e330.75k in the fourth year and so on. The revenue would be received continuously throughout each year. 1

The revenue and costs cease 20 years after the outset of the project, and the project has no further value. Calculate the internal rate of return from the project. 4.6 An investor borrows e10,000 at an eective rate of 15% per annum to nance a project. Income from the project is received at a level rate of e1,800 per annum, payable quarterly in arrears, for 20 years. Calculate the discounted payback period. 4.7 (a) A leasing company borrows e175,000 at an eective rate of 7 1 % per annum to nance a 2 project that is expected to generate income of e24,000 at the end of each year for the next 15 years. Find the discounted payback period for this investment. (b) Under the same borrowing conditions as in (a), suppose instead that the company will receive income at a level rate of e22,000 per annum payable continuously for 15 years. Calculate the new discounted payback period for this project. 4.8 In return for an investment of e80,000 now and e5,000 at the end of one year, an investor will receive a continuous payment stream at the rate of e10,000 per annum, commencing at the end of year two. Find the discounted payback period (DPP) for this transaction. Assume an eective rate of interest of 7% per annum. [Hint: Writing the equation of value in present-value terms, one can solve for t directly. Alternatively, try to obtain two estimates for the DPP, one which gives a positive NPV and the other a negative NPV, and then apply linear interpolation over these two estimates.] 4.9 An investor borrows e90,000 at an eective interest rate of 5 1 % per annum. The investor uses 2 the money to purchase an annuity of e12,000 per annum payable quarterly in arrears for 20 years. Once the loan is paid o, the investor can earn interest at an eective rate of 4% per annum on money invested from the annuity payments. (a) Determine the discounted payback period for this investment. (b) Determine the prot which the investor will have made at the end of the term of the annuity. 4.10 To mark a composers anniversary in 2012, a recording studio is to produce a commemorative CD for sale over a 6-year period from 1 January 2007 until 31 December 2012. The development costs will be e10,000, of which e5,000 will be incurred on 1 January 2005, e3,000 on 1 July 2005 and e2,000 on 1 January 2006. The production cost of each CD is assumed to be incurred at the beginning of the calendar year of production and will be e6 during 2007. The sale price of each CD is assumed to be received at the end of the calendar year of production. Both the production costs and the sale prices are assumed to increase by 5% on each 1 January, the rst increase occurring on 1 January 2008. It is also assumed that 5,000 CDs will be produced each year and that all will be sold. The sale price of each CD produced in 2007 is e8. (a) Calculate the discounted payback period at an eective rate of interest of 7% per annum. (b) Without doing any further calculations, explain whether the discounted payback period would be greater than, equal to, or less than the period calculated in part (a) if the eective rate interest were substantially less than 7% per annum.

Answers to MS216 Tutorial Questions 1.1 1.2 1.3 1.4 1.5 e14,800.73 e3,354.25 e3,327.16 e9,866.18241 e16,457.73957 Option 4: e5,250 e1,640.43692 e1,642.09881 e1,641.26143 e1,641.5419 d(12) 4.95% = 5.05% (i) 8.16%; (ii) 7.8698% (iii) 7.5444%; (iv) 7.8441% e278.97046 e278.40114 e5,906.30382 e6,426.27034 e777.38074 e42,338.35692 6.3764 years = 6.91629% i 7.51% i 9.71% a10 = 7.81635 a8 = 6.83917 s5 = 5.4981 s16 = 24.28405 e15,000.00 e20,848.79 & e20,459.03 e41,187.89885 e132,014.85803 e4,544.94296 e20,000.1375 Ranking: (4), (3), (1), (2) i 7.51% i 4.54% e42,000 e40,000 (Ia)10 = 40.0082 3 a8 = 5.68051 a5 = 4.4623 s16 = 23.7292 e13,486.83263 e8,006.72725 e6,010.68253 e886.81 e2,240.94 e1,494.74136 Option (2) e26,122.98446 3.1 (a) i (a) ii (a) iii (a) iv (b) (a) (b) (c) (d) (e) (a) (b) (a) (b) (c) (a) (b) (c) (a) (b) (c) e21,452.63 e5,181.09 & e16,271.54 23rd payment 16th payment e12,523.53 e68.480417 e6,485.7561 e26.858862 e516.19811 & e305.56689 107th instalment (10/6/1987) e633.8400 e40,516.3842 e238.1717 e1,705.48208 e22.2920 e389.95922 e263.38954 e456.49319 e9,307.76455 e5,764.41223 e1,619.98358 e119.99067 6.3% 26.7% 9.1% (A) 21.2% & (B) 18.7% (A) e211,577 & (B) e286,814 e6,378.91 e1,950.50 22.8% 9.48% 1 11 4 years 11 years 11.84 17.768 9 3 years 4 e152,017.88572 4 years Shorter DPP

(a) (b) (a) (b) (a) (b) (c) (d)

3.2

1.6 1.7 1.8

3.3 3.4

(a) (b)

1.9 1.10 1.11 1.12 1.13 1.14 1.15 2.1

3.5

(a) (b) (a) (b)

3.6

3.7 3.8 3.9 3.10 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 (a) (b)

2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11

(a) (b) (c) (d) (a)

(a) (b)

(a) (b) (a) (b) (a) (b)

(a) (b) (a) (b) (c) (d)

2.12 2.13 2.14 2.15 2.16 2.17 2.18

(a) (b)

25 February 2008