The Theory of Interest - Solutions Manual

Chapter 1
1. (a) Applying formula (1.1)

A ( t ) = t 2 + 2t + 3 and A ( 0 ) = 3
so that
A(t ) A(t ) 1 ( 2
a (t ) = = = t + 2t + 3) .
k A (0) 3

(b) The three properties are listed on p. 2.

1
(1) a ( 0 ) = ( 3) = 1.
3

1
(2) a′ ( t ) = ( 2t + 2 ) > 0 for t ≥ 0,
3
so that a ( t ) is an increasing function.

(3) a ( t ) is a polynomial and thus is continuous.

(c) Applying formula (1.2)

I n = A ( n ) − A ( n − 1) = [ n 2 + 2n + 3] − ⎡⎣( n − 1) + 2 ( n − 1) + 3⎤⎦
2

= n 2 + 2n + 3 − n 2 + 2n − 1 − 2 n + 2 − 3
= 2n + 1.

2. (a) Appling formula (1.2)

I1 + I 2 + … + I n = [ A (1) − A ( 0 )] + [ A ( 2 ) − A (1)] + + [ A ( n ) − A ( n − 1)]
= A( n) − A ( 0).

(b) The LHS is the increment in the fund over the n periods, which is entirely
attributable to the interest earned. The RHS is the sum of the interest earned
during each of the n periods.

3. Using ratio and proportion

5000
(12,153.96 − 11,575.20 ) = $260.
11,130

4. We have a ( t ) = at 2 + b, so that

a ( 0) = b = 1
a ( 3) = 9a + b = 1.72.

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The Theory of Interest - Solutions Manual Chapter 1

Solving two equations in two unknowns a = .08 and b = 1. Thus,

a ( 5 ) = 52 (.08 ) + 1 = 3

a (10 ) = 102 (.08 ) + 1 = 9 .

a (10 ) 9
and the answer is 100 = 100 = 300.
a ( 5) 3

5. (a) From formula (1.4b) and A ( t ) = 100 + 5t

A ( 5 ) − A ( 4 ) 125 − 120 5 1
i5 = = = = .
A( 4) 120 120 24
A (10 ) − A ( 9 ) 150 − 145 5 1
(b) i10 = = = = .
A (9) 145 145 29

6. (a) A ( t ) = 100 (1.1) and

t

A ( 5 ) − A ( 4 ) 100 ⎡⎣(1.1) − (1.1) ⎤⎦

5 4

i5 = = = 1.1 − 1 = .1.
A ( 4) 100 (1.1)
4

A (10 ) − A ( 9 ) 100 ⎡⎣(1.1) − (1.1) ⎤⎦

10 9

(b) i10 = = = 1.1 − 1 = .1.

A(9) 100 (1.1)
9

7. From formula (1.4b)

A ( n ) − A ( n − 1)
in =
A ( n − 1)
so that
A ( n ) − A ( n − 1) = in A ( n − 1)
and
A ( n ) = (1 + in ) A ( n − 1) .

8. We have i5 = .05, i6 = .06, i7 = .07, and using the result derived in Exercise 7

A ( 7 ) = A ( 4 ) (1 + i5 )(1 + i6 )(1 + i7 )
= 1000 (1.05 )(1.06 )(1.07 ) = $1190.91.

9. (a) Applying formula (1.5)

615 = 500 (1 + 2.5i ) = 500 + 1250i
so that

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The Theory of Interest - Solutions Manual Chapter 1

1250i = 115 and i = 115 /1250 = .092, or 9.2%.

(b) Similarly,
630 = 500 (1 + .078t ) = 500 + 39t
so that
39t = 130 and t = 130 / 39 = 10 / 3 = 3 1 3 years.

10. We have
1110 = 1000 (1 + it ) = 1000 + 1000it
1000it = 110 and it = .11
so that
⎡ ⎛3⎞ ⎤
500 ⎢1 + ⎜ ⎟ ( i )( 2t ) ⎥ = 500 [1 + 1.5it ]
⎣ ⎝4⎠ ⎦
= 500 [1 + (1.5 )(.11)] = $582.50.

11. Applying formula (1.6)

i .04
in = and .025 =
1 + i ( n − 1) 1 + .04 ( n − 1)
so that
.025 + .001( n − 1) = .04, .001n = .016, and n = 16.

12. We have
i1 = .01 i2 = .02 i3 = .03 i4 = .04 i5 = .05
and adapting formula (1.5)
1000 ⎡⎣1 + ( i1 + i2 + i3 + i4 + i5 ) ⎤⎦ = 1000 (1.15 ) = $1150.

13. Applying formula (1.8)

600 (1 + i ) = 600 + 264 = 864
2

which gives
(1 + i )2 = 864 / 600 = 1.44, 1 + i = 1.2, and i = .2
so that
2000 (1 + i ) = 2000 (1.2 ) = $3456.
3 3

14. We have
(1 + i )n 1+ i
= (1 + r ) and 1 + r =
n

(1 + j ) 1+ j
n

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The Theory of Interest - Solutions Manual Chapter 1

so that
1+ i (1 + i ) − (1 + j ) i − j
r= −1 = = .
1+ j 1+ j 1+ j
This type of analysis will be important in Sections 4.7 and 9.4.

15. From the information given:

(1 + i )a = 2 (1 + i )a = 2
2 (1 + i ) = 3 (1 + i ) = 3/ 2
b b

3 (1 + i ) = 15 (1 + i )c = 5
c

6 (1 + i ) = 10 (1 + i ) = 5 / 3.
n n

5 2 1
By inspection = 5 ⋅ ⋅ . Since exponents are addictive with multiplication, we
3 3 2
have n = c − a − b.

16. For one unit invested the amount of interest earned in each quarter is:
Quarter: 1 2 3 4
Simple: .03 .03 .03 .03
1.03 − 1 (1.03) − 1.03 (1.03) − (1.03) (1.03)4 − (1.03)3
2 3 2
Compound:
Thus, we have
D ( 4) ⎡⎣(1.03)4 − (1.03)3 ⎤⎦ − .03
= = 1.523.
D ( 3) ⎡⎣(1.03)3 − (1.03)2 ⎤⎦ − .03

17. Applying formula (1.12)

A : 10, 000 ⎡⎣(1.06 ) + (1.06 ) ⎤⎦ = 6808.57

−18 −19

B : 10, 000 ⎡⎣(1.06 ) ⎤⎦ = 6059.60

−20 −21
+ (1.06 )
Difference = $748.97.

18. We have
vn + v2n = 1

and multiplying by (1 + i )
2n

(1 + i )n + 1 = (1 + i )2 n
or
(1 + i )2 n − (1 + i )n − 1 = 0 which is a quadratic.

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The Theory of Interest - Solutions Manual Chapter 1

Solving the quadratic

(1 + i )n = 1 ± 1 + 4 = 1 + 5 rejecting the negative root.
2 2
Finally,
2
⎛ ⎞
(1 + i ) = ⎜ 1 + 5 ⎟ = 1 + 2 5 + 5 = 3 + 5 .
2n

⎝ 2 ⎠ 4 2

19. From the given information 500 (1 + i ) = 4000 or (1 + i ) = 8.

30 30

The sum requested is

10, 000 ( v 20 + v 40 + v 60 ) = 10, 000 ( 8− 3 + 8− 3 + 8−2 )

2 4

⎛1 1 1 ⎞
= 10, 000 ⎜ + + ⎟ = $3281.25.
⎝ 4 16 64 ⎠

20. (a) Applying formula (1.13) with a ( t ) = 1 + it = 1 + .1t , we have

I 5 a ( 5 ) − a ( 4 ) 1.5 − 1.4 .1 1
d5 = = = = = .
A5 a ( 5) 1.5 1.5 15

(b) A similar approach using formula (1.18) gives

a −1 ( t ) = 1 − dt = 1 − .1t
and
−1 −1
I 5 a ( 5 ) − a ( 4 ) (1 − .5 ) − (1 − .4 )
d5 = = =
A5 a ( 5) (1 − .5 )−1
1/ .5 − 1/ .6 2 − 5 / 3 6 − 5 1
= = = = .
1 − 1/ .5 2 2⋅3 6

21. From formula (1.16) we know that v = 1 − d , so we have

200 + 300 (1 − d ) = 600 (1 − d )
2

6d 2 − 12d + 6 − 2 − 3 + 3d = 0
6d 2 − 9d + 1 = 0 which is a quadratic.

Solving the quadratic

9 ± ( −9 ) − ( 4 ) ( 6 ) (1) 9 − 57
2

d= =
2⋅6 12
rejecting the root > 1, so that
d = .1208, or 12.08%.

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The Theory of Interest - Solutions Manual Chapter 1

22. Amount of interest: iA = 336.

Amount of discount: dA = 300.
Applying formula (1.14)
d 336 300 / A 300
i= and = =
1− d A 1 − 300 / A A − 300
so that
336 ( A − 300 ) = 300 A
36 A = 100,800 and A = $2800.

23. Note that this Exercise is based on material covered in Section 1.8. The quarterly
discount rate is .08/4 = .02, while 25 months is 8 1 3 quarters.

(a) The exact answer is

5000v 25 / 3 = 5000 (1 − .02 ) = $4225.27.

25 / 3

(b) The approximate answer is based on formula (1.20)

5000v8 (1 − 13 d ) = 5000 (1 − .02 ) ⎡⎣1 − ( 13 ) (.02 ) ⎤⎦ = $4225.46.

8

The two answers are quite close in value.

24. We will algebraically change both the RHS and LHS using several of the basic
identities contained in this Section.

( i − d )2 ( id )2 2
RHS = = = i d and
1− v d
d3 i 3v 3 3
LHS = = = i v = i 2d .
(1 − d ) 2
v 2

25. Simple interest: a ( t ) = 1 + it from formula (1.5).

Simple discount: a ( t ) = 1 − dt from formula (1.18).
−1

Thus,
1
1 + it =
1 − dt
and
1 − dt + it − idt 2 = 1
it − dt = idt 2
i − d = idt.

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The Theory of Interest - Solutions Manual Chapter 1

26. (a) From formula (1.23a)

−4 3
⎛ d ( 4) ⎞ ⎛ i ( 3) ⎞
⎜1 − ⎟ = ⎜1 + ⎟
⎝ 4 ⎠ ⎝ 3 ⎠
so that
⎡ ⎛ i ( 3) ⎞ − 4 ⎤
3

= 4 ⎢1 − ⎜1 + ⎟ ⎥.
( 4)
d
⎣⎢ ⎝ 3 ⎠ ⎦⎥
(b)
6 −2
⎛ i ( 6) ⎞ ⎛ d ( 2) ⎞
⎜1 + ⎟ = ⎜1 − ⎟
⎝ 6 ⎠ ⎝ 2 ⎠
so that
⎡⎛ d ( 2 ) ⎞ − 3 ⎤
1

= 6 ⎢⎜ 1 − ⎟ − 1⎥ .
( 6)
i
⎢⎣⎝ 2 ⎠ ⎥⎦
27. (a) From formula (1.24)
( m) ( m) i ( m) d ( m)
i −d =
m
so that
⎛ i( m) ⎞
⎟ = d (1 + i ) .
( m) ( m) ( m) 1
i =d ⎜1 +
m

⎝ m ⎠

(b) i ( m) measures interest at the ends of mths of a year, while d m is a comparable

( )

( )
measure at the beginnings of mths of a year. Accumulating d m from the
beginning to the end of the mthly periods gives i ( m) .
( )
i 4 .06
28. (a) We have j = = = .015 and n = 2 ⋅ 4 = 8 quarters, so that the accumulated
4 4
value is
100 (1.015 ) = $112.65.
8

(b) Here we have an unusual and uncommon situation in which the conversion
frequency is less frequent than annual. We have j = 4 (.06 ) = .24 per 4-year
period and n = 2 (1/ 4 ) = 1 2 such periods, so that the accumulated value is
−.5 −.5
100 (1 − .24 ) = 100 (.76 ) = $114.71.

29. From formula (1.24)

( ) ( m)
( ) ( m) imd
i m −d =
m

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The Theory of Interest - Solutions Manual Chapter 1

so that
( ) ( )
imdm (.1844144 )(.1802608 )
m = ( m) ( m) = = 8.
i −d .1844144 − .1802608

30. We know that

( ) ( )
i4 i5
= (1 + i ) 4 = (1 + i ) 5
1 1
1+ and 1 +
4 5
so that
− 15
RHS = (1 + i ) 4 = (1 + i ) 20
1 1

LHS = (1 + i ) n
1
and n = 20.

( ) ( 4)
31. We first need to express v in terms of i 4 and d as follows:
4
⎛ d ( 4) ⎞
= 4 (1 − v.25 )
( 4)
v = 1 − d = ⎜1 − ⎟ so that d
⎝ 4 ⎠
and
−4
⎛ i ( 4) ⎞
i 4 = 4 ( v −.25 − 1) .
−1
( )
v = 1 + i = ⎜1 − ⎟ so that
( )

⎝ 4 ⎠
Now
4 ( v −.25 − 1)
( )
i4
r= = = v −.25 so that v.25 = r −1 and v = r −4 .
d
( 4)
(
4 1− v .25
)
( ) ( )
32. We know that d < i from formula (1.14) and that d m < i m from formula (1.24). We
( ) ( ) ( )
also know that i m = i and d m = d if m = 1 . Finally, in the limit i m → δ and
( )
d m → δ as m → ∞ . Thus, putting it all together, we have
( m) ( )
d <d < δ < i m < i.

33. (a) Using formula (1.26), we have

A ( t ) = Ka t bt d c
2 t

ln A ( t ) = ln K + t ln a + t 2 ln b + ct ln d
and
d
δt = ln A ( t ) = ln a + 2t ln b + ct ln c ln d .
dt
(b) Formula (1.26) is much more convenient since it involves differentiating a sum,
while formula (1.25) involves differentiating a product.

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The Theory of Interest - Solutions Manual Chapter 1

a A (t ) d
.10
34. Fund A: a A ( t ) = 1 + .10t and δ tA = =dt
.
a ( t ) 1 + .10t
A

d B( )
( ) ( ) −1 dt a t .05
Fund B: a t = 1 − .05t
B
and δ t = B
B
= .
a ( t ) 1 + .05t
Equating the two and solving for t, we have
.10 .05
= and .10 − .005t = .05 + .005t
1 + .10t 1 − .05t
so that .01t = .05 and t = 5 .

35. The accumulation function is a second degree polynomial, i.e. a ( t ) = at 2 + bt + c .

a ( 0) = c= 1 from Section 1.2
a (.5 ) = .25a + .5b + c = 1.025 5% convertible semiannually
a (1) = a + b + c = 1.07 7% effective for the year
Solving three equations in three unknowns, we have
a = .04 b = .03 c = 1.

36. Let the excess be denoted by Et . We then have

Et = (1 + it ) − (1 + i )
t

which we want to maximize. Using the standard approach from calculus

d
Et = i − (1 + i ) ln (1 + i ) = i − δ (1 + i ) = 0
t t

dt
(1 + i )t = i and t ln (1 + i ) = tδ = ln i − ln δ
δ
so that
ln i − ln δ
t= .
δ

37. We need to modify formula (1.39) to reflect rates of discount rather than rates of
interest. Then from the definition of equivalency, we have
a ( 3) = (1 + i ) = (1 − d1 ) (1 − d 2 ) (1 − d3 )
3 −1 −1 −1

−1 −1 −1
= (.92 ) (.93) (.94 ) = .804261−1
and
− 13
i = (.804264 ) − 1 = .0753, or 7.53%.

38. (a) From formula (1.39)

a ( n ) = (1 + i1 )(1 + i2 )…(1 + in ) where 1 + ik = (1 + r ) (1 + i )
k

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The Theory of Interest - Solutions Manual Chapter 1

so that
a ( n ) = [(1 + r ) (1 + i )] ⎡⎣(1 + r ) (1 + i ) ⎤⎦ … ⎡⎣(1 + r ) (1 + i ) ⎤⎦
2 n

and using the formula for the sum of the first n positive integers in the exponent,
we have
n( n +1) / 2
a ( n ) = (1 + r ) (1 + i )n .
(b) From part (a)
( ) ( )
(1 + j ) = (1 + r )n n+1 / 2 (1 + i )n so that j = (1 + r ) n+1 / 2 − 1.
n

39. Adapting formula (1.42) for t = 10, we have

a (10 ) = e5 .06 e5δ = 2, so that e5δ = 2e−.3
( )

and
δ = ln ( 2e −.3 ) = .0786, or 7.86%.
1
5
20

40. Fund X: a ( 20 ) = e ∫ 0
(.01t +.1) dt
X
= e 4 performing the integration in the exponent.

Fund Y: aY ( 20 ) = (1 + i ) = e 4 equating the fund balances at time t = 20 .

20

The answer is
= ( e4 )
.075
aY (1.5 ) = (1 + i ) = ⎡⎣(1 + i ) ⎤⎦
.075
= e.3 .
1.5 20

41. Compound discount:

a ( 3) = (1 − d1 ) (1 − d 2 ) (1 − d 3 ) = (.93) (.92 ) (.91) = 1.284363
−1 −1 −1 −1 −1 −1

using the approach taken in Exercise 37.

Simple interest: a ( 3) = 1 + 3i.

Equating the two and solving for i, we have
1 + 3i = 1.284363 and i = .0948, or 9.48%.

42. Similar to Exercise 35 we need to solve three equations in three unknowns. We have
A ( t ) = At 2 + Bt + C
and using the values of A ( t ) provided
A (0) = C = 100
A (1) = A + B + C = 110
A ( 2 ) = 4 A + 2 B + C = 136
which has the solution A = 8 B = 2 C = 100 .

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The Theory of Interest - Solutions Manual Chapter 1

A ( 2 ) − A (1) 136 − 110 26

(a) i2 = = = = .236, or 23.6% .
A (1) 110 110

A (1.5 ) − A (.5 ) 121 − 103 18

(b) = = = .149, or 14.9%.
A (1.5 ) 121 121

A′ ( t ) 16t + 2 21.2
(c) δ t = = 2 so that δ1.2 = = .186, or 18.6% .
A ( t ) 8t + 2t + 100 113.92

A (.75 ) 106
(d) = = .922.
A (1.25 ) 115

43. The equation for the force of interest which increases linearly from 5% at time t = 0
to 8% at time t = 6 is given by
δ t = .05 + .005t for 0 ≤ t ≤ 6.
Now applying formula (1.27) the present value is
6
− ∫ ( .05+.005 t ) dt
−1
( )
1, 000, 000a 6 = 1, 000, 000e 0
= 1, 000, 000e −.39 = $677, 057.

44. The interest earned amounts are given by

⎡⎛ i⎞
16
⎛ i⎞ ⎤
15
⎛
15
i⎞ ⎛i⎞
A : X ⎢⎜ 1 + ⎟ − ⎜ 1 + ⎟ ⎥ = X ⎜ 1 + ⎟ ⎜ ⎟
⎣⎝ 2 ⎠ ⎝ 2⎠ ⎦ ⎝ 2⎠ ⎝ 2⎠
i
B : 2X ⋅ .
2
Equating two expressions and solving for i
15 15
⎛ i⎞ ⎛i⎞ ⎛ i⎞
i = 2 ( 21/15 − 1) = .0946, or 9.46%.
i
X ⎜1 + ⎟ ⎜ ⎟ = 2 X ⋅ ⎜1 + ⎟ = 2
⎝ 2⎠ ⎝2⎠ 2 ⎝ 2⎠

45. Following a similar approach to that taken in Exercise 44, but using rates of discount
rather than rates of interest, we have
A : X = 100 ⎡⎣(1 − d ) − (1 − d ) ⎤⎦ = 100 (1 − d ) ⎡⎣(1 − d ) − 1⎤⎦
−11 −10 −10 −1

B : X = 50 ⎡⎣(1 − d ) − (1 − d ) ⎤⎦ = 50 (1 − d ) ⎡⎣(1 − d ) − 1⎤⎦ .

−17 −16 −16 −1

Equating the two expressions and solving for d

−10 −16
100 (1 − d ) = 50 (1 − d ) (1 − d )−6 = 2 (1 − d )−1 = 2 16 .
Finally, we need to solve for X. Using A we have
X = 100 ⋅ 2
10
6 ( 2 − 1) = 38.88.
1
6

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The Theory of Interest - Solutions Manual Chapter 1

46. For an investment of one unit at t = 2 the value at t = n is

n n −1
( n − 1)2
a ( n ) = e∫ 2 = e ∫ 2
δ t dt 2 ( t −1) 2 ln ( t −1)]2
= ( n − 1) .
dt n
=e =
2

( 2 − 1) 2

Now applying formula (1.13)

a ( n + 1) − a ( n ) n 2 − ( n − 1)
2

dn = =
a ( n + 1) n2
and
⎛ n −1⎞
2

1 − dn = ⎜ ⎟ .
⎝ n ⎠
( )
Finally, the equivalent d n 2 is
⎡ n − 1⎤ 2
d n2 = 2 ⎡⎣1 − (1 − d n ) 2 ⎤⎦ = 2 ⎢1 −
( ) 1
= .
⎣ n ⎥⎦ n

1
47. We are given i = .20 = , so that
5
i 1/ 5 1
d= = = .
1 + i 1 + 1/ 5 6
We then have
−1
⎡ 1 1⎤ −1
PVA = (1.20 ) ⎢1 + ⋅ ⎥
⎣ 2 5⎦
−1 ⎡ 1 1⎤
PVB = (1.20 ) ⎢1 − ⋅ ⎥
⎣ 2 6⎦
and the required ratio is
PVA (1 + 110 )
−1
10 12 120
= = ⋅ = .
PVB 1 − 112 11 11 121

δ2 δ3 δ4
48. (a) i = eδ − 1 = δ + + + +
2! 3! 4!
using the standard power series expansion for eδ .
i 2 i3 i 4
( )
(b) δ = ln 1 + i = i − + − +
2 3 4
using a Taylor series expansion.

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The Theory of Interest - Solutions Manual Chapter 1

= i (1 + i ) = i (1 − i 2 + i 2 − i 3 + ) = i − i 2 + i 3 − i 4 +
i −1
(c) d =
1+ i
using the sum of an infinite geometric progression.
⎛ d2 d3 d4 ⎞
( )
(d) δ = − ln 1 − d = − ⎜ − d − − − − ⎟
⎝ 2 3 4 ⎠
adapting the series expansion in part (b).

dd d ⎛ i ⎞ (1 + i ) − i −2
49. (a) = ⎜ ⎟= = (1 + i ) .
di di ⎝ 1 + i ⎠ (1 + i ) 2

dδ d 1 −1
(b) = ln (1 + i ) = = (1 + i ) .
di di 1+ i
dδ d 1
(c) = ( − ln v ) = − = −v −1.
di dv v
d (
1 − e −δ ) = −e −δ ( −1) = e −δ .
dd
(d) =
dδ dδ

50. (a) (1) a ( t ) = e ∫ 0

( a + br ) dr
= e at +bt / 2 .
2

a (n) e an +.5bn
2
( )
(2) 1 + in = = ( ) ( )2 = e an +.5bn − an + a −.5bn +bn−.5b = e a −b / 2 +bn .
2 2

a ( n − 1) e a n −1 + .5 b n −1

(b) (1) a ( t ) = e ∫ 0
abr dr ( )
= e a b −1 / ln b .
t

a (n) a ⎡( n ) ( n −1 ) ⎤
⎣ b −1 − b −1 ⎦ ( ) n −1
(2) 1 + in = =e ln b
= e a b −1 b / ln b .
a ( n − 1)

13