II-22

PRACTICE MULTIPLE CHOICE TEST 6

1. Fund A accumulates at a force of interest 1 +0.~5t at time t, for t 2: 0, and Fund B

accumulates at a constant force of interest .05. You are given:

(i) The amount in Fund A at time zero is 1000.

(ii) The amount in Fund B at time zero is 500.
(iii) The amount in Fund C at any time t, for t 2: 0, is equal to the sum of the amounts in
Fund A and Fund B. Fund C accumulates at a force of interest Dt, for t 2: O.

Calculate 82.
---=----'"-,.

(C) 1 + e'!
2 + e'!
(E) 2 + el
(A) t6b (B) fdo 44 + 20e·1

2. Gertrude deposits 10,000 in a bank. During the first year the bank credits an annual
effective rate of interest i. During the second year the bank credits an annual effective rate
of interest (i - 5%). At the end of two years she has 12,093.75 in the bank. What would
Gertrude have in the bank at the end of three years if the annual effective rate of interest
were (i + 9%) for each of the three years?

(A) 16,851 (B) 17,196 (C) 17,499 ~J 17,936 (E) 18,113

3. John borrows 1000 from Jane at an annual effective rate of interest i. He agrees to pay back
1000 after six years and 1366.87 after another six years. Three years after his first payment
John repays the outstanding balance. What is the amount of John's second payment?

(A) 1020
§: 1027 (C) 1048 (D) 1073 (E) 1094

4. Payments of 300,500 and 700 are made at the end of years five, six, and eight, respectively.
Interest is accumulated at an annual effective rate of 4%. You are to find the point in time at
which a single payment of 1500 is equivalent to the above series of payments. You are
g1Ven:

(i) X is the point in time calculated by the method of equated time.

(ii) Y is the exact point in time.

Calculate X + Y.
(B) 13.50 (C) 13.55 (D) 14.61 (E) 14.99
013.44

I
 Il-23

5. An annuity-immediate pays an initial benefit of 1 per year, increasing by 10.25% every four
years. The annuity is payable for 40 years. Using an annual effective interest rate of 5%,
determine an expression for the present value of this annuity.

(C) 2· a201

6. You are given an annuity-immediate paying 10 for 10 years, then decreasing by 1 per year
for nine years and paying 1 per year thereafter, forever. The annual effective rate of interest
is 4%. Calculate the present value of this annuity.

f) 119
(B) 121 (C) 123 (D) 125 (E) 127

7. Which of the following are true?

1. (ani - %)(1 + i) = an-IJ·

Il. The present value of a 10-year temporary annuity-immediate paying 10 per month for
the first 8 months of each year is 120 . alOi . a~~~)21'
Ill. The present value of a perpetuity paying one at the end of each year, except paying
s-
nothing every fourth year, is t . ~_ .
4J

(A) I & IT (B) I & III (C) IT & III (D) All (E) None of A, B, C, D

8. Humphrey purchases a 100,000 home. Mortgage payments are to be made monthly for 30
years, with the first payment to be made one month from now. The annual effective rate of
interest is 5%. After 10 years the amount of each monthly payment is increased by 325.40
in order.to repay the mortgage more quickly. Calculate the amount of interest paid over the
duration of the loan.

o 66,300
(B) 68,500 (C) 70,100 (D) 70,700 (E) 74,400

9. Warren has a loan with an effective interest rate of 5% per year. He makes payments at the
end of each year for 10 years. The first payment is 200, and each subsequent payment
increases by 10 per year. Calculate the interest portion of the fifth payment.

(A) 58 (B) 60 (C) 62 ~i~5 (E) 67

 IT-24 ••
1O. You are given a IS-year mortgage with monthly payments of 1000 and interest compounded ••
monthly. At the end of each month you make a payment of 1000. In addition to the regular
monthly payment of 1000, you make an additional payment equal to the amount of principal
that would have been repaid in the next regular monthly payment. Under this scheme the
•.-
loan will be completely repaid after 90 payments. Determine an expression for the amount
of interest saved over the life of the loar;. ••
(A) 1000 [90 - (1 +i) a~;I] CD) 1000 [90 - (1 +i) a~~OI] ••
••
(B) 1000 [90 _ (1+i) a.~~I]
a21 CE) 1000 [90 - (1 +i) a.~~OI]
s21
••
fJJ

••
(C) 1000 [90 - (1 +i) ~~I] •••
•••
11. A 1000 bond with coupon rate c convertible semiannually will be redeemed at par in n years . ••
The purchase price to yield 5% convertible semiannually is P. If the coupon rate were
c - .02, then the price of the bond would be P - 300. Another 1000 bond is redeemable at ••
par at the end of 2n years. It has a coupon rate of 7% convertible semiannually and the yield ••
rate is 5% convertible semiannually. Calculate the price of this second bond .
••
e.-
(A) 1300 @) 1375 (C) 1475 (D) 2100 (E) 2675 •••
A loan of 1,000,000 obtained on 1/1/97 is to be repaid by 360 level monthly payments,
••
starting on 1/31/97, at an interest rate of X% per year, compounded monthly. The portion 0-
of the monthly payment on 9/30/02 applied to interest is 94.473%. The portion of the
~ 12
monthly payment on 10/31/02 applied to interest is 94.418%. Calculate X.
•••
~
(A) 12.00 (B) 12.25 (C) 12.50 (D) 12.75 (E) 13.00

/ 13. On January 1 an insurance company has 100,000 which is due to Linden as a life insurance
death benefit. He chooses to receive the benefit annually over a period of 15 years, with the
first payment immediately. The benefit he receives is based on an effective interest rate of
4% per year. The insurance company earns interest at an effective rate of 5% per year.
Every July 1 the company pays 100 in expenses and taxes to maintain the policy. At the
end of nine years the company has X remaining. Calculate X.
CA) 46,000 (B) 47,100 (C) 47,700 (D) 52,800 CE) 53,900

14. An investment fund accumulates with force of interest 6t = 1 + (¥-t)K ' for 0 S t S 1.
At time zero there is 100,000 in the fund. At time one there is 110,000 in the fund. The
only two transactions during the year are a deposit of 15,000 at time .25 and a withdrawal
of20,000 at time .75. Calculate K.
~,
(A) .047 CB) .051
e .141
(D) .150 CE) .154

\
 II-25

15. Bob has a choice of two loans when bo::owing money to purchase a home. Loan X is a 30-
year adjustable rate mortgage for 100,000. The interest rate for the first year is 4.5%
convertible monthly. In the second year, the mortgage rate increases to 6.5% convertible
~
monthly. In the third year, the mortgage rate increases to 8.5% convertible monthly and
remains at 8.5% convertible monthly for the remainder of the loan. Loan Y is a 30-year
fixed rate mortgage for 100,000. The interest rate is 7.5% convertible monthly. Calculate
the difference in the outstanding loan balances immediately after the 36th monthly payment
for Loan X and Loan Y.

(A) 275 (B) 503 (C) 698 (D) 829 (E) 904

16. Bill purchases an annuity at a price of 10,000. The annuity makes payments of 500 at the
beginning of every 6 months for 20 years. The payments are reinvested in a fund which
earns interest at an annual effective rate i. Interest payments are received every 6 months
and reinvested at a nominal rate of 6% convertible semiannually. Bill realizes an overall
effective annual yield of7% on his original investment over the 20-year period. Calculate i.

(A) 5.90% (B) 6.05% (C) 6.20% (D) 6.35% (E) 6.50%

17. The earnings of a corporation increase at 2% per quarter indefinitely. Each quarter the
corporation plans to pay 40% of its earnings as a stock dividend. At the start of a quarter,
an investor purchases the stock to yield a nominal rate of 10% compounded semiannually.
The first stock dividend is 2.00 payable at the end of the quarter. Calculate the theoretical
price of the stock.

(A) 406 (B) 418 (C) 426 (D) 435 (E) 447

( .
 ill-28

SOLUTIO~S TO PRACTICE MULTIPLE CHOICE TEST 6

1.
We are given F.:,(t) = ::<: =::.= ~j:1 +0.~5r dr] = 1000
exp [In(l .. -.=
+ .0Sr) ~. ICC':, :-.05t),
-
c

FE(t) = 500· exp LJ,~

. / ',05 dr I
J
= 500· e·05t, and FeCO) = FA(O) + FE(O) = 1500. Then c
- r' ,
•
FeCt) = 1500·exp •./·f"drj = 1000(1+.05t)+500·e,05t .
C

j'
Taking logs, In 1500...,...
of this equation we have
c" dr = In [1000(l+.05t) + 500· e,05t]. Differentiating both sides
,
C

f
8t = [ 1000 (1+.O)t_~+ 50 0 . e' 05t] [(1000)(.05) + (500)(.05)e·05t], so that
4

f
= [1100+~00'e.l][50+25'e']] = 44~~rle'l' ANSWERD.
82
•
f
2. We are given 10,000(1+i)(l+i-.05) = 12,093.75, and we seek 1O,000(1+i-.09)3. We find i
f
f
= =
from the first equation as (l+i)(.95+i) 1.209375, leading to i2 + 1.95i - .259375 O.
•
Th·
en z = -1.95 + -/(1.95)2 - 4(-.259375)
2 = .. 125 Th h .
us t e answer IS f
10,000(1.215)3 = 17,936.13, ANSWER D. f
•
•
3. Originally the equation of value is 1000 = 1000v6 + 1366.87vI2. This is replaced by f
1000 = 1000v6 + p. v9, so P = (1366.87vI2)(1+i)9 = 1366.87v3; note that i is not •
known. The original equation is quadratic in x
± -/(000)22(1366.87)
= v6, namely, 1366.87x2 + 1000x - 1000 = O. •
Tb - 6 - -1000 - 4(1366.87)(-1000) - 56447 Th .-
v3
en x -
= jX =
v -
.75131, so P = (1366.87)(,75131) = 1026.95,
- .. en
ANSWERB .
•
••
ta
4. B t d t·
y equa e Ime,
X = (300)(5) + (500)(6) + (700)(8)
1500
101
= 'T5'
(I
Exactly, 1500vY

vY =
= 300v5

(300)(.82193) + (500i~6~031)
+ 500v6 + 700v8, so

+ (700)(.73069) = .76881.
•(i
fa

Then Y = In .76881
In (1.04)-1'
= 6.70338 and X +Y = 6.70338 + 101
15'
= 13.437 ANSWER A.
•(I
••

-•
••
 ill-29

5. First we value each group of fo'''::- pa)ments at the beginning of its four-year period. This gives

values of a4j at t = 0, (1.1025)cZ- at t = 4, (1.1025)2a4j at t = 8, ... , (1.1025)9a4j at t = 36.

Th e overa 11present va 1·ue IS tnen

. pLoy -- a41
- [1 + (I.05)4 (1.05)8
1.1025 + (1.1025i + ... + (1.1025)9]
(1.05)36 .
But 1.1025 = (1.05)2, so this reduces to

PV = a4j[I+v2+t.4+ ... +v18]

ANSWERB.
-' I-v 2
1 - z v4 (I_V20)
-'
_ (1-v2)(1Z +v2) I-v 2
(I_V20)
-
_ (1 +V 2) a20/
_
'

6. The payments are as follows:

10 10 10 9 8 1 1
I
o
I
1
I
2
I
10
I
11
I
12
I
19
I
20

Then PV
- 10· aTOj + (Da)9f' vJO + + . vI9
- (10)(8.1109) + 9 - ~'J353 (.6756) + .64 (.4746) 119.40, ANSWER A.

7. I.
(a;;-j - %)(1+i) = (I-v;-d )(1+i) = (~)(1+i) = 1 _In-l = an_I/, so
yes.
n. 120 . ~ values the 8 payments for each year at the beginning of the year. The overall
8/121

present value would then be found using a factor of iilOj , not alOj, so no.
ill.
The value of each set of 3 payments is a3j , valued at the beginning of each payment set.
These values of a3j would exist at times 0, 4, 8, ... , and their overall value at t =0
a- a- s-
would be a3j (1 +V4+V8+ ... ) = -1 - 31v 4 = i. d- 41
=1= i. ~_ ,41
so no. Only I is true,
ANSWERE
 ll1-JU •
•
•
8. Here the monthly rate 0 ~:::e:-es::s:
. p
payment IS = a-
100. 00
36-J :
-~.
= ::':'.','J::.
P
= (1.05)1/12 - 1
I
= .0040741.
Tb eoutstan d'mg b aancea ft er 10' years
The initial monthly
IS • ••
DElO = 530.05a240: = s: ,06-:-.68.
term of the loan is n years, v,'::ere 81,067.68
The monthly payment is increased to 855.45, so the new

= 855.45a;r, giving
••
( l+z")-n = 1 -z .,(81.06"'.68)
~,,'1'
~_)."t) =. 61391 , 1ea d'mg ton = -In''"(.61391)
.. h = 120 . Th erelore
.• ••
Humphrey pays 10 years at 530.05 and another 10 years at 855.45, for total payments of ••
(120)(530.05) + (120)(855.45) = 166,260. Since 100,000 is principal, the total interest paid is ••
66,260, ANSWER A . o.
••
(Calculator comments: Several steps in the amortization can be done efficiently with the annuity •••
keys. To convert the effective annual rate of 5% to an effective monthly rate and compute the ••
monthly payment, hit IAC/ONI, enter 5, hit 12ndlll>APRI, enter 12, hit I = 11 -7- I, enter 12, hit ••
I = iI%il, enter 360, hit [R], enter 100,000, hit !PVI, and then hit ICPTIIPMT! to obtain 530.06 as ••
the monthly payment. To obtain the balance after ten years (120 payments), enter 240, hit lliJ, ••
and then hit lCPTIIPVI to obtain BAL120 = 81,068.48 (prospective calculation). To increase the er-
payment and recompute the mortgage term, hit IRCLlIPMTI[±:], enter 325.40, hit 1= IIPMTI,
e-
and then hit ICPTllRl, producing 120 months as the new term.)
••
••
~

9. After 4 years the outstanding balance is

DB4 = 240v + 250v2 + '" + 290v6 = 230a6j.os + (I a~.os·

The interest portion of the fifth payment is

15 = i· OB4 = '230(I-v6) + 10(ii6j-6v6)

= (230)(1-.74621) + (10)[(1.05)(5.07574) - (6)(.74621)]
= 66.89, ANSWERE.

10. By paying the following principal amount in advance, the interest that would have been due at
that time is saved. There were (15)(12) = 180 payments originally scheduled. The interest that
is saved comes from the interest otherwise due in the 90 even-numbered payments. Thus the
interest saved is

1000 (1_vI79) + 1000(1-v177) + ... + 1000(1-v) = 1000 [90 - (v+v3+ ... +v179)]

= 1000 [90 - (1 +i)(v2 + v4 + ... + vISO)]

= 1000 [90 - (1 +i) ( a;;1 ) ], ANSWER D.

 ill-:~...

11. We are given PI = 1000 + (500C-25)c:> .. C:5' and

I
PI - 300 = 1000 + (500C - :O-25)c:" .0:5' We seek P2 = 1000 + (35 - 25)a4nl.025' I
Subtracting the second equatior. ton the first gives us 300 = 10· a2n!.025' so a2nl = 30. We

need a4nl = a2nl + a2nl . 7...2~•. i\ote that a2nl = 1.02S2n = 30, so vln = .25. Therefore
a4nl = 30 + 30(.25) = 37.50, ane P2 = 1000 + (10)(37.50) = 1375, ANSWER B.

12. The payment due on 9/30102 is the 69th payment, so P!4,9 = p. v360+1-69 = p. v292. The
portion of the payment applied to principle is p.~292 = v292 = (1- .944 73), from which we find
v=.990133,asthemonthlydiscountfactor. Then X = 12(v-1-1) = .1196, ANSWER A

(Note: The given information that P R70 = (1- .94418)P is unnecessary, but could have been
. 1 - .94473 _ v292 _
used to obtam 1 AA A 1 () - 29T
v - v.)

13. Th 1 . P 100,000 100,000 864820 Th ' b 1

e annua payment IS = a!5i.04 = (1.04)(11.11836) = .. e company s a ance
after nine years is the accumulation of the initial fund, less the accumulation of payments and
expenses, all valued at 5%. Then

x = 100,000(1.05)9 - 8648.20· 591.05 - 100· 891.05(1.05)1/2

= 100,000(1.55133) - 8648.20(1.05)(11.0266) - 100(11.0266)(1.0247)

= 53,874.86, ANSWERE.

(Calculator comments: The annuity keys can expedite this solution. First calculate the payment
as follows: hit IAC/ONI12ndlIBGNI, enter 15, hit~, enter 4, hit ~, enter 100,000, hit IPVI,
and then hitlCPTllpMTI to obtain 8648.18. The balance at time 9 can be rewritten as

100,000(1.05)9 - (8648.18 + 100(1.05)-1/2)891.05, To evaluate, enter

8648.18 + 100(1.05)-1/2 = 8745.77, hit IPMTI, enter 9, hit!R], enter 5, hit I%il, and then hit
ICPTIIFVI to obtain 53,875.20.)

I
I.
 4

•
•
14, Csing a force of interest, the ba:a:12e at the end of the year is
,,
f

100,000 [ex<l6' dt) ] +15,000 ~exp (L 6, dt) ] -20,000 [exp(L6' dt) ] = 110,000,

,•
•
Note that exp ([

so k [lOO,000+.75(15.
6, dt)
Thus we have 100,000,:-::
OGe'l
=

-
ex," , -in:1 + (l-t)k{)
- i5.000(1+.75k)
.25(20,000)] =
=
- 20,000(1+.25k)
15,000, so k =
[1 + (I-r)k],

.14117,
= 110,000,
ANSWER C.
:•
•
15. For the fixed rate Loan Y, the payment and balance after 36 months are obtained from the

= P . a3601.075/12'
••
•
calculator's annuity keys from the relations 100,000 from which we find

P = 699.21, and BAL36 =P = 97,014.25 (reset [H] to 324 and hit ICPT! IPVI ).
. a3241.075/12
With the variable rate mortgage, there are six equations with the following calculator steps:
•••
(i) Enter 360, hit I~, enter 4.5 1+ 112, hit f%ll, enter 100,000, hit IPVI, and then hit ICPT IIPMTI
fir
(ii)
to get a first year payment of 506.68 per month .
Reset [R] to 348 and hit ICPT1IPVIto obtain a first year ending balance of 98,386.77.
(iii) Reset I%il to 6.5 I + 112 and hit ICPTI!PMTI to obtain the second year payment of 628.90 per
month.
•
••
••
(iv) Reset ~ to 336 and hit ICPTIIPVI to obtain a second year ending balance of 97,200.17. f!lII
Cv) Reset I%il to 8.5 I + 112 and hit ICPTI!PMTI to obtain the third year payment of 759.37 per
month.
(vi) Reset ~ to 324 and hit!CPTIIPVI to obtain the third year ending balance of96,315.77.
The difference in the balances after 36 months is 97,014.25 - 96,315.77 = 698.48,
ANSWERC

16. The annuity payments of 500 each, invested at rate j = (1+i)1/2 - 1, produce a series of interest
payments of 500j, 2(500j), 3(500j), ... , 40(500j), at the end of each half-year for 20 years.
These interest payments are invested at .03 effective per half-year, and accumulate to
500 j(! 8)401.03at the end of 20 years. The annuity payments themselves, without interest, amount
to 40(500) = 20,000. The total accumulation represents the growth, at 7% per year, of the
original investment of 10,000. Thus we have 10,000(1.07)20 = 20,000 + 500j(I8)401.03' so

j = 10'OO~~6~P~ 20,000 = .02979, and i

8 401.03 = (1+j)2 - 1 = .06046, ANSWERB
17. If the dividend is 2.00, the:: :':-.==..:....-:-~:-.~S
',l,'=:e5.00 in the first quarter. Subsequent earm::p -;;'-.-
be 5(1.02), 5(1.02i, and se ::-, ~_: s..:':sequent dividends will be 2(1.02), 2(1.02)2, an::: s.:
The present value ofsucl: C:-.-.:e:-.:s. '.<-.:;:-: is the theoretical price of the stock, is

Note well that v = (1 - __--:S ':2se::: on an effective quarterlyratej, where (1 + j)2 = 1.('5
Then

? = 2v[1 + (1.02)v + [(1.02)vj2 + ...].

We can sum the in::!".::e ge:,:::e::ic series, with r = 1.02v, to obtain

p _ 2v 2
- - 1-1.02v = (1 ()<;\112_1 ()') = 425.98,

ANSWERC