Actuarial Society of India

EXAMINATIONS
2nd November (a.m.)
Subject 102– Financial Mathematics
Time allowed: Three Hours

INSTRUCTIONS TO THE CANDIDATES

1. Do not write your name anywhere on the answer scripts. You have only to write your Candidate’s
Number on each answer script.

2. Mark allocations are shown in brackets.

3. Attempt all 14 questions, beginning your answer to each question on a separate sheet.

4. Fasten your answer sheets together in numerical order of questions. This, you may complete
immediately after expiry of the examination time.

5. In addition to this paper you should have available graph paper, Actuarial Tables and an
electronic calculator.

AT THE END OF THE EXAMINATION

Hand in both your answer scripts and this question paper to the supervisor separately
 ASI 102 1003

.. ( p )
and a n and hence find a&&n( p ) , given
i i
Q.1 Derive an expression for an using
i ( p) ,
p
i i
( p)
= 1.012348, = 0.025 and a n = 7.721735 .
i p
[Total 3]

Q.2 The manufacturer of a certain toy sells to retailers on either of the following terms:
- Cash payment: 30% below recommended retail price;
- Six months credit: 25% below recommended retail price.

Find the effective annual rate of discount on the credit price offered by the manufacturer to retailers
who pay cash. Express this as an effective annual interest rate on the cash price charged to those
retailers who accept the credit terms.

The manufacturer is considering changing his credit terms. Credit for six months will no longer be
available, but for three months’ credit the price payable will be 27.5% below the recommended retail
price. The terms for cash payment will be unaltered.

Does this new arrangement offer a greater or lower effective annual rate of discount on the credit
price to cash purchasers?
[Total 5]

Q.3 The force of int erest δ (t ) is a function of time and at any time, measured in years, is given by the
formula

0.02 + 0.05t 0≤t ≤ 5

δ (t ) = 
0.06 5< t

a) Derive and simplify, as far as possible, an expression for v (t ) where v (t ) is the present value of
a unit sum of money due at time t . Your answer should include separate expressions for values
of 0 ≤ t ≤ 5 and t > 5 .
(5)
b) A continuous payment stream is received at the rate of 25e −0 .03t
units per annum between t = 7
and t = 12 . Calculate the present value of the payment stream.
(4)
[Total 9]

Q.4 A common practical approximation is often used to find the number of years in which a sum of
money will double itself at compound interest. This is given as below:

“Divide 70 by the rate of interest per cent”.

If the effective rate of interest per annum be “i” then mathematically justify the practical
approximation.
[Total 3]

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 ASI 102 1003

Q.5 On 1 November 2002 a man was in receipt of the following three annuities, all payable by the same
insurance company:

a) Rs.200 per annum payable annually on 1 February each year, the final payment being on
1 February 2024.
b) Rs.320 per annum payable quarterly on 1 January, 1 April, 1 July and 1 October each year, the
final payment being on 1 January 2019;
c) Rs.180 per annum payable monthly on the first day of each month, the final payment being on
1 August 2021.

Immediately after receiving the monthly payment due on 1 November 2002, the man requested that
these three annuities be combined into a single annuity payable half- yearly on 1 February and
1 August in each subsequent year, the final payment being made on 1 February 2024. The man’s
request was granted.

Find the amount of the revised annuity, given that it was calculated on the basis of an interest rate of
8% per annum effective, all months being regarded as of equal length.
[Total 10]

Q.6 A loan of Rs.2000 is repayable by a level annuity-certain, payable annually in arrear for
eighteen years. The amount of the annual repayment is calculated on the basis of an effective annual
interest rate of 10% for the first six years and 9% thereafter.

a) Find
i) the amount of the annual repayment
ii) the amount of capital contained in the fourth repayment
iii) the amount of capital contained in the twelfth repayment
(8)

b) Immediately after making the twelfth repayment the borrower makes an additional capital
repayment of Rs.100, the amount of the annual repayment being appropriately reduced.
Assuming that the interest basis is unaltered, find the amount of the revised repayment.
(2)
[Total 10]

Q.7 A loan of nominal amount of Rs. 100000 is to be issued bearing interest payable annually in
arrear at the rate of 8% per annum. The terms of the issue provide that the borrower shall repay the
loan (at par) in ten consecutive annual instalments each of nominal amount of Rs.10000, the first
repayment being made any time (at the borrower’s option) between 10 and 25 years from the issue
date.

An investor, liable to income tax at the rate of 40%, wishes to purchase the entire loan on the issue
date at a price to guarantee him a net yield of at least 7% per annum.

What price should he pay?

[Total 10]

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 ASI 102 1003

Q.8
a) In return for an immediate outlay of Rs. 10000 an investor will receive Rs. 6000 in one year’s
time and Rs. 6600 in two year’s time. Find, to the nearest 0.1%, the internal rate of
return on this investment.
(3)

b) A person who has no spare cash may make the investment described in (a) above, by borrowing
the initial outlay from a bank.

The bank offers a loan for a two-year period and charges interest of 16% per annum annually in
arrear, with provision for any part-repayment at the end of first year.

Calculate the profit / loss the person will have made when the transaction is completed at the end
of 2 years under each of the following assumptions.

(1) Repayments of the loan are made using the receivable amounts given in 8(a).
(2) Out of the receivable amounts only the interest is paid at the end of the first year and the
balance is used as spare money to earn interest of 13% per annum effective.
(4)
[Total 7]

Q.9 An insurance company is to develop a new single premium product to be sold from 1st January 2005
for six years until 31 st December 2010. The cost of developing the product will be Rs 2,500,000; of
which Rs 1,500,000 will be incurred on 1st January 2003, Rs 500,000 on 1st July 2003 and Rs
500,000 on 1st January 2004.

The single premium of Rs 6000 from the sale of each unit of the product is assumed to be
received at the end of the calendar year of sale.

The cost incurred in selling each unit of the product is assumed to be incurred uniformly
throughout the calendar year of sale and will be Rs 4000 during 2005. Selling costs per unit of the
product are assumed to increase by 5% on each 1st January, the first increase occurring on 1 st January
2006.

It is also assumed that 500 units of the product will be sold in each calendar year. There are no other
cashflows that arise from the product during the six calendar years.

Calculate the discounted payback period at an effective rate of interest of 6% per annum.
[Total 9]

Q.10
a) Define a swap, in the context of financial instruments.
b) Describe the how the pricing of a swap will be done.
c) Describe the risks faced by the parties involved in a swap.

[Total 7]

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 ASI 102 1003

Q.11 An investor purchases a fixed interest security. The security pays coupons at rate of 10% per
annum half- yearly in arrear, and is to be redeemed at 110 in 20 years. The investor is subject to tax
on the coupon payments at the rate of 20%.

One year after purchasing the security, the price at which it can be sold is at a level that will yield a
rate of return of 10% per annum effective. At this time, a second investor agrees a forward contract
to buy the security four years from then, immediately after the coupon payment then due.

Calculate the forward price based on a “risk- free” rate of return of 10% per annum effective and no
arbitrage.
[Total 4]

Q.12 Explain briefly what happens to the yields on fixed interest securities if:

a) The demand for fixed-interest securities falls

b) The government issues many more fixed- interest securities
c) Institutional investors suddenly decide to invest less in equities and more in fixed- interest
securities
[Total 3]

Q.13 An insurance company has a liability of Rs. 100000 due in eight years’ time. The company, which
has exactly sufficient money to cover the liability on the basis of a constant force of interest of 5%
per annum ( which is also the market basis for pricing all stocks), now wishes to invest this money in
a mixture of the following securities:

a) Zero-coupon bonds redeemable at par in 20 years’ time

b) Cash

The company requires that, on the basis of a constant force of interest of 5% per annum, the
discounted mean term of the assets equal that of the liabilities. Find the amounts to be invested in
each of securities a) and b).
[Total 8]

Q.14 A bank offers a savings account that allows private investors to invest in a selection of common
shares. At the end of each year a deduction of 1% is made from the value of the investor’s
accumulated fund to cover the bank’s expenses. There is also an initial deduction (for commission)
of 2% of each sum invested.

One model used to describe the growth of an investor’s holding assumes that the growth rate in
successive years (ignoring the deductions) can be considered to take independent values from a
statistical distribution with mean µ and variance σ 2 .

(a) Use this model to find formulae in terms of µ and σ 2 for the mean and variance of the
accumulated value at the end of the k th year, allowing for the deductions for expenses and
commission, if an initial sum of A is invested.
(6)

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ASI 102 1003

(b) The growth rates (before deductions) for the last 10 years were:
12.7%, 12.3%, 12.3%, 13.3%, 13.7%, 15.9%, 18.7%, 25.5%, 11.4%, 12.1%

i) Use these values to estimate the values of µ and σ 2 in the model.

ii) Hence estimate the mean and standard deviation of the investment proceeds that will be
obtained by an investor who invests a single sum of Rs.6,000 in an account for a 5 year
period.
(6)

[You are given that the sample mean and sample variance of the data values x1 , x2 ,...., xn are
1 n 1 n 2 2
x= ∑
n i =1
x i and s 2
= ∑ x i − nx  respectively. ]
n − 1  i =1 

[Total 12]

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