UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN Actuarial Science Program DEPARTMENT OF MATHEMATICS

Math 210 Theory of Interest Prof. Rick Gorvett Fall, 2011

Homework Assignment # 2 (max. points = 10) Due at the beginning of class on Thursday, September 8, 2011 You are encouraged to work on these problems in groups of no more than 3 or 4. However, each student must hand in her/his own answer sheet. Please show your work enough to show that you understand how to do the problem and circle your final answer. Full credit can only be given if the answer and approach are appropriate. Please give answers to two decimal places e.g., xx.xx% and $xx,xxx.xx .

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At what constant force of interest will you triple your money in 10 years? There are two alternative investment accounts. Account A involves investing $1,000 at a force of interest of 10%; the accumulated value after three years will be X. Account B involves investing $1,000 at a nominal interest rate of i ( 2 ) 11% ; the accumulated value after three years will be Y. Find the value of Y X. At a nominal annual interest rate of 9% convertible monthly, how long will it take you to double your money? (Provide an answer in years, to two decimal places.) If you invest $500 now, how much will you have 45 months from now if your money grows at a nominal annual rate of 7% convertible quarterly? A cash flow of $5,000 fifty-one (51) months from now has a present value, now, of $2,800. Find the nominal annual rate convertible semi-annually that is consistent with this situation. Abby offers to pay you $2,000 three years from now. Ben offers to pay you $2,500 at time t. The effective annual interest rate is 8%. Find the value of t such that you are indifferent between Abby's and Ben's offers. (Note: indifference means that both offers have the same present value.) Express t in years, to two decimal places. You have the following choice in buying a product: Option A: You can pay 20% below the current retail price now. Option B: You can pay 5% below the current retail price one year from now.

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At what annual effective rate of interest are you indifferent between these two options? (Note: this is a very common type of problem in theory of interest. Again, interpret indifference to mean that the present values (now) of the two options are equal.) (8) You have the following choice in buying a product: Option A: You can pay 30% below the current retail price now. Option B: You can pay 10% below the current retail price two years from now. At what annual effective rate of interest are you indifferent between these two options? (9) Cash flows of $500 at time 1 and $300 at time 2 have a total present value at time 0 of $700. Find the constant effective annual interest rate i consistent with this situation. (Note: You might find the quadratic formula useful.) $2,000 is invested for ten years. For the first five of those years, the interest rate is i ( 4 ) 12% . For the second five years, the interest rate is i (12 ) 8% . Find the accumulated value of the investment at the end of the ten years.

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