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Actuarial Society of India

EXAMINATIONS
31st May 2003 (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. 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


ASI 102 05 03

Q.1 Prove, by general reasoning,

1 1
= +i
an Sn
[3]

Q.2 The force of interest is given by,

δ (t ) = 0.05 + 0.001t + 0.0001t 2 0 ≤ t ≤ 10

a) Calculate the total at time 10 of the accumulated proceeds of an investment


of Rs100 at time 0 plus an investment of Rs 100 at time 5. [5]

b) Calculate the equivalent constant force of interest earned on the transaction. [3]

Q.3 A policyholder has obtained a quotation for purchasing an index- linked


annuity certain from a life office. In return for the purchase price of Rs
10,00,000, the policyholder will receive 10 annual payments starting one
year from now. The first payment will be Rs 1,25,000 and future payments
will be increased in line with price inflation. If the life office assumes a
constant nominal rate of interest of 8% per annum in the calculation, find
the constant rate of inflation assumed. [5]

Q.4 A salaried person aged exactly 35 now wishes to make 15 annual payments
starting today into a pension plan. His aim is to provide for the expenses to
be incurred, towards his daughter’s education, when he is aged 55.

The expenses to be incurred are an initial lump sum of Rs 50,000 payable at


age 55, and an annuity certain of Rs 20,000 per annum payable half- yearly
in arrear during the next 6 years.

In calculating how much annual payment to invest each year, the person
has assumed that

• an effective rate of interest of 7% per annum will be achieved


during the 20- year period, and that,
• the annuity certain can be purchased at a price that will yield a
nominal rate of interest of 6% per annum convertible half-
yearly.

a) Assuming that the amount of each payment during any period of 5 years is
half the amount of each payment in the subsequent 5 years, calculate the
amount of the first annual payment. [5]

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ASI 102 05 03

b) Under the pension plan,

• the rate of interest actually earned over the 20- year period is 6%
per annum effective, and
• the annuity certain is purchased at age 55 at a nominal rate of
5% per annum convertible half- yearly.

Assuming that the person makes the payments as in a) above, calculate the
revised amount of the initial lump sum that will be available. [5]

Q.5 A film producer has spent an amount of Rs 1,00,000 on making a film.

The film generates revenues for a year at the rate of Rs 1,20,000 per annum
during the first month, Rs 1,10,000 per annum during the second month and
so on till Rs 10,000 in the twelfth month. Assume that the revenues are
received continuously during each month.

Assuming an interest rate of 6% per annum convertible half- yearly,


calculate at the end of the year the net gain or loss made by the film
producer.

Assume that all months are of equal length. [5]

Q.6 A borrower is repaying one debt of Rs.4000 by 30 equal half- yearly


instalments of principal and interest calculated at 5% per annum
convertible half- yearly of which the 12th payment has just been paid, and
another debt of Rs.1500 by 20 equal half- yearly instalments of principal
and interest calculated at 4% per annum convertible half- yearly of which
the 8th instalment has just been paid.

If the remaining instalments of the two debts are to be replaced by an


annuity-certain of 20 half- yearly payments, what rate of interest should be
paid on the combined loan so that the total sum to be paid in future by the
borrower will not be altered.

Assume that all annuities are payable in arrear. [10]

Q.7 An investment manager of a life insurance company purchased a 10-year


Government of India fixed interest bond with 7% interest per annum
payable half- yearly in arrear with a gross redemption yield of 7%. There is
an excellent secondary market for this bond.

List the reasons why the net real actual yield that will be achieved can be
less than what is expected.
[3]

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ASI 102 05 03

Q.8 a) Describe the practical difficulties in estimating future cashflows to


investors in equity shares. [5]

b) List reasons why the running yield from property investment is expected to
be higher than that for ordinary shares. [5]

Q.9 A mutual fund sells units to unit holders. It retains any income earned on its
investments within the fund. Unit holders can redeem units available in
their account based on the unit price on 1st April each year. The Unit price
on 1st April in each year is:

Year 1996 1997 1998 1999 2000 2001 2002


Unit price on
1.86 2.11 2.55 2.49 2.88 3.18 3.52
1st April
a) For an initial investme nt of Re.1 on 1st April 1996, find the time weighted
rate of return and linked internal rate of return for the fund over the period
1st April 1996 to 1 st April 2002 (ignore expenses of transaction).

In order to allow for expenses, the mutual fund sells units at a price that is
2% more than the above-mentioned unit price and buys back units at a price
that is 2% below the above- mentioned price. [2]

b) Write down the equation of value to find the yield obtained by an investor
who purchased 200 units on 1st April in each year, from 1996 to 2001
inclusive, and who sold back his holding to mutual fund on 1st April 2002. [2]

c) Write down the equation of value to find the yield obtained by an investor
who invested Rs.500 in the fund on 1st April in each year, from 1996 to
2001 inclusive, and who sold back his holding to mutual fund on 1st April
2002. [2]

d) List the disadvantages of using time weighted rate of return and money
weighted rate of return in assessing the performance of an investment fund
manager.
[3]

Q.10 Explain the difference between a future contract and forward contract. [2]

Q.11 A 3-month forward contract is issued on 1st February 2003 on a stock with
a price of Rs 500 per share. Dividends are received continuously and the
dividend yield is 3% per annum. In addition, it is anticipated that a special
dividend of Rs 100 per share will be paid on 1st April 2003.
Assuming a risk free force of interest of 5% per annum and no arbitrage,
calculate the forward price per share of the contract.
[3]
Q.12 A company is liable to make four payments at five-yearly intervals, the first
payment being due five years from now. The amount of the tth payment is
Rs (1000+100t). The company values these liabilities at an effective rate of
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ASI 102 05 03

interest of 5% per annum.

a) Find the present value and the discounted mean term of these liabilities. [4]

b) An amount equal to the total value of the liabilities (on the basis of an
effective annual interest rate of 5%) is immediately invested in two newly
issued loans, one redeemable at the end of ten years and the other at the end
of 30 years.

Each loan bears interest at 5% per annum payable annually in arrear. Both
the loans are issued and redeemable at par.

Given that, on the basis of an effective annual interest rate of 5%, the
discounted mean term of the asset-proceeds is the same as the discounted
mean term of the liability – outgo, determine how much is invested in each
of the loans. [6]

Q.13 A certain irredeemable stock pays interest at 5.5% per annum payable
quarterly on 31st March, 30th June, 30th September and 31st December.
a) On 31st August 2001 this stock was quoted at a price of Rs 49.50 per Rs
100 nominal. Find the gross nominal yield per annum, convertible half-
yearly. [3]

b) An investor bought Rs 20,000 nominal of this stock on 31 August 2001 at


the price quote in a) above. Exactly one year later he sold this holding at a
price such that the purchaser’s gross nominal yield per annum, convertible
half- yearly was 10%. Find the net annual yield obtained by the investor on
the entire transaction, given that he pays tax on income at 40% and on
capital gains at 30%. [6]

Q.14 The yields i t , t = 1, 2,..., n on a company’s fund in different years are


independently and identically distributed. Each year the distribution of
(1 + i t ) is log-normal with parameters µ and σ 2 .

Let Vn be the random variable denoting the present va lue of Re 1 due at the
end of n years.

a) Show that Vn has a log–normal distribution and find the parameters of the
distribution. [3]

b) Assuming further that each year the yield, i t , has mean value 0.08 and
standard deviation 0.05; find the expected value and the standard deviation
of the present value of Rs 1000 due at the end of 10 years.
[10]

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