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ACTUARIAL SOCIETY OF INDIA

EXAMINATIONS: NOVEMBER 2000


Subject 102: Mathematics of Finance.

Time allowed: Three hours- Maximum marks 100

1. Write your candidates number in the space provided.


2. Do not write your name anywhere in the answer sheets.
3. Mark allocations are shown in brackets.
4. Actuarial Tables and graph paper will be available on request.***
5. You may use simple electronic calculators, but not programmable or capable of storing
prior data.
6. Attempt all 14 questions

1) Calculate ( Iä )20 when δ = 0.08 [3]

2) In return for an initial investment of Rs. 10,000 an investor will receive Rs. 12500 in 5 years' time. In
addition there is a 50% chance that the investor will receive a further payment of Rs. 5000 in 10 years'
time. Calculate the expected yield on this investment. [3]

3) Given δ = 0.10, calculate i, l(4) and d (12) [3]

4) What is "Hodging"? [2]

5) An investor is considering the purchase of 1000 shares in a company, Dividends on the share will be
paid annually. The next dividend is due in one year and is expected to be 90Ps. per share. The second
dividend is expected to be 9% greater than the first and the third dividend is expected to be 8% greater
than the second. Thereafter the dividend is expected to grow at 5% p.a. compound in perpetuity.
Calculate the present value of this dividend stream at a rate of interest of 7% p.a effective. [5]
n
6) Prove by general reasoning the relationship ( Ia )n = än - nv [4]

7) Explain briefly the following:


(i) Futures
(ii) Options
8) Under a hire purchase scheme, a person buys a refrigerator by availing a loan on 1st July 2000 and
agrees to repay by six equal monthly installments starting from 31st January 2001. If the interest on
the loans is calculated using a flat rate of 7 1/2% p.a, determine the APR (Annual percentage rate of
charge) for the transaction. [5]
9)
a) A 3-year index linked security is issued at time 0. The security pays nominal coupons of
5%annually in arrears and is redeemable at par. The coupons and capital repayment are inflated by
reference to the inflation index value 8 months before the payment is made. The inflation index
value 8 months before the payment was 105.
The table below shows the index value at other times.

Time 4 . 4. 4.
0 1 1 2 2 3
12
12 12

Index 107 110 111 113 114 117 120

Calculate the real yield if the price of the stock is Rs. 97. [6]

b) For the last 10 years a man has paid Rs. 5000 at the start of each month into a recurring deposit
account with a bank that has achieved a real rate of interest of 3% per annum over the period. If the
inflation rate has been at a constant rate of 5% per annum calculate the balance in his account
today. [2]

10) The following data related to the assets of an investment fund:

Date Market value (in Crores)


1 January, 1997 Rs. 29.40
1 January, 1998 Rs. 32.20
1 January, 1999 Rs. 35.70
1 July, 1999 Rs. 35.70
3 December, 1999 Rs. 38.50

The only cash flow during the calendar years 1997, 1998 and 1999 that was not generated from the
assets of the fund was a payment of Rs. 140,00,000 received by the fund on 30 june, 1999. For the
period from 1 January 1997 to 31 December 1999 calculate:
a) The money-weighted rate of return.
b) The time-weighted rate of return, and
c) The linked annual rate of return.

Express your answers as annual rate rounded to the nearest 0.1%. [9]

11)
i) State the two situations when an arbitrage opportunity exists. [2]
ii) Explain what is meant by the "no arbitrage" assumption in financial mathematics. [3]
iii) A fixed interest security pays coupons of 8% p.a half-yearly in arrears and is redeemable at
110%. Two months before the next coupon is due, an investor negotiates forward contract in
which he agrees to buy Rs. 5 lakhs nominal of the security in ten months' time. The current
price of the stock is Rs. 8.40 per Rs. 100 nominal and the risk free force of interest is 5% p.a

Calculate the forward price of this contract assuming no arbitrage. [5]


12)
i) On 15 July 1996 an investor subject to 40% tax on income purchased, at a price of Rs 80% a
holding pf 3 1/2% stock. This stock pays half-yearly coupons and can be assumed to be
redeemable on 14 July, 2004. Calculate the net yield that will be obtained if the stock is held to
redemption, assuming that income tax is payable on 1 November each year in respect of any
coupons received during the previous year [from 1 April to 31 March]. [7]
ii) A stock of nominal amount of Rs 20,00,000 is redeemable in four equal installments, the first
being at the end of 11 years' time. Redemption is at par and the interest of 8 1/2% per annum is
payable half yearly in arrears. An investor, who pays capital gains tax at 30% [payable as soon
as it becomes due] but is not subject to income tax, requires a net yield of 10% per annum.
What price should he pay? [7]
13) In any year the yield on funds invested with a given insurance company has mean value and standard
deviations and is independent of the yields in all previous years.
i) Derive formulae for the means and variance of the accumulated value after n years of a single
investment of 1 at time 0 [7]

ii) Each year the value of (1+ it ), where i, is the rate of interest in the tth year, is log normally
distributed. The rate of interest has a mean value of j = 0.08 and standard deviations = 0.1 in all
years.

a) Find the parameters µ and σ2 for the log-normal distribution of (1+ it ). [4]
b) Find the distribution of S20 where S20 denotes the accumulation of one unit of money of 20
years. [3]
14) A loan is repayable by an increasing annuity payable annually in arrears for 15 years. The repayment
at the end of first year is Rs. 200,000 and subsequent repayments increase by Rs. 20,000. every year.
The repayments were calculated using a rate of interest of 12% per annum effective.
i) Calculate the amount of loan originally granted. [4]
ii) Construct the schedule of repayment for years nine and ten [ie. immediately after the 8th
repayment installment], showing the outstanding loan at he beginning of the year, the
repayment installment, interest portion and capital repayment portion in each year. [5]
iii) Immediately after the tenth installment of repayment, the rate of interest on the outstanding loan
is reduced to 10% per annum effective. Calculate the amount of the eleventh repayment
installment if the subsequent installments continue to increase at Rs. 20,000 each year and the
loan is repaid by the original date i.e. 15 years from the commencement. [6]

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