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Theory of Interest Chapter 2 Solutions
Theory of Interest Chapter 2 Solutions
Chapter 2
1. The quarterly interest rate is
( )
i 4 .06
=
= .015
4
4
and all time periods are measured in quarters. Using the end of the third year as the
comparison date
j=
i 12 .18
j=
=
= .015.
12 12
Using the end of the third month as the comparison date
v 5 = .40188 or
(1 + i )5 = 2.4883.
4. The quarterly discount rate is 1/41 and the quarterly discount factor is
1 1/ 41 = 40 / 41 . The three deposits accumulate for 24, 16, and 8 quarters,
respectively. Thus,
24
16
8
40
3 40
5 40
However,
1
40
= 1.025
41
so that
25
19
13
A ( 28 ) = 100 (1.025 ) + (1.025 ) + (1.025) = $483.11 .
14
Chapter 2
so that
n
1.06
=2
1.04
n [ ln1.06 ln1.04] = ln 2
and
n=
.693147
= 36.4 years .
.058269 .039221
and n =
ln (.54988 )
= 9.66 years.
ln (.94 )
15
Chapter 2
v2n + vn 1 = 0
1 1 ( 4 )(1)( 1) 1 + 5
=
2
2
= .618034 rejecting the negative root.
We are given i = .08 , so that
vn =
n 2 + ( 2n ) + " + ( n 2 )
n 2 (1 + 22 + " + n 2 )
t =
=
.
n + 2n + " + n 2
n (1 + 2 + " + n )
2
We now apply the formulas for the sum of the first n positive integers and their
squares (see Appendix C) to obtain
n 2 ( 16 ) ( n )( n + 1)( 2n + 1) 1
2n 2 + n
(
)(
)
.
= n 2n + 1 =
n ( 12 ) ( n )( n + 1)
3
3
10. We parallel the derivation of formula (2.4)
(1 + i )n = 3 or n =
ln 3
ln (1 + i )
ln 3
.08
1.098612
.08
i ln (1.08 )
i
.076961
1.14
=
or a rule of 114, i.e. n = 114.
i
10 2 n
B: 10 (1.0915)
+ 30 (1.0915 )
= 67.5
10
10v n + 30v 2 n = 67.5 (1.0915 ) = 28.12331
v 2 n + .33333v n .93744 = 0.
Solving
2
.33333 (.33333) ( 4 )(1) ( .93744 )
v =
= .81579
2
n
16
Chapter 2
and
n=
ln (.81579 )
= 2.33 years.
ln (1.0915 )
a A ( t ) = (1.01)
12 t
and
r / 6 dr
2
a B (t ) = e 0
= et /12 .
Equate the two expressions and solve for t
(1.01)12t = et
/12
144 t
or (1.01) = et
144t ln (1.01) = t 2
and t = 144 ln (1.01) = 1.43 years.
13. Let j be the semiannual interest rate. We have
1000 (1 + j ) = 3000
30
3 (1 + 2i + i 2 ) + 2 (1 + i ) 6 = 0
3i 2 + 8i 1 = 0.
Solving the quadratic
i=
=
8 82 ( 4 ) ( 3) ( 1) 8 76
=
( 2 ) ( 3)
6
8 + 2 19
19 4
=
6
3
17
Chapter 2
(1 + i )10 = 1.41212
v10 = .708155 or
and i =
1825
= .015, or 1.5%.
55,000
17. We have
10
a (10 ) = e 0
t dt
10
= e 0
ktdt
= e50 k = 2
so that
50k = ln 2 and k =
ln 2
.
50
18. We will use i to represent both the interest rate and the discount rate, which are not
equivalent. We have
(1 + i )3 + (1 i )3 = 2.0096
(1 + 3i + 3i 2 + i 3 ) + (1 3i + 3i 2 i 3 ) = 2.0096
2 + 6i 2 = 2.0096 or 6i 2 = .0096
i 2 = .0016 and i = .04, or 4%.
19. (a) Using Appendix A
We then have
= 365 341
1941:
1942 :
24
365
1943:
365
1944:
1945:
366
220
(leap year)
Total =
1340
days.
360 (Y2 Y1 ) + 30 ( M 2 M 1 ) + ( D2 D1 )
= 360 (1945 1941) + 30 ( 8 12 ) + ( 8 7 ) = 1321 days.
18
Chapter 2
20. (a)
62
I = (10,000 ) (.06 )
= $101.92.
365
(b)
60
I = (10,000 ) (.06 )
= $100.00.
360
(c)
62
I = (10,000 ) (.06 )
= $103.33.
360
n
21. (a) Bankers Rule: I = Pr
360
n
Exact simple interest: I = Pr
365
where n is the exact number of days in both. Clearly, the Bankers Rule always
gives a larger answer since it has the smaller denominator and thus is more
favorable to the lender.
n*
(b) Ordinary simple interest: I = Pr
360
where n* uses 30-day months. Usually, n n* giving a larger answer which is
more favorable to the lender.
(c)
96 (1 + i )
.25
= 100
100
and i =
1 = .1774, or 17.74%.
96
23. (a) Option A - 7% for six months:
1.03441
= 1.0124.
1.02178
19
Chapter 2
1.10682
= .9938.
1.11374
24. The monthly interest rates are:
.054
.054 .018
= .0045 and y2 =
= .003.
12
12
The 24-month CD is redeemed four months early, so the student will earn 16 months
at .0045 and 4 months at .003. The answer is
y1 =
16
4
5000 (1.0045 ) (1.003) = $5437.17.
25. The APR = 5.1% compounded daily. The APY is obtained from
.051
1 + i = 1 +
365
365
= 1.05232
APY .05232
=
= 1.0259.
APR
.051
Note that the term APR is used for convenience, but in practice this term is typically
used only with consumer loans.
26. (a) No bonus is paid, so i = .0700, or 7.00%.
3
(b) The accumulated value is (1.07 ) (1.02 ) = 1.24954, so the yield rate is given by
(c)
27. This exercise is asking for the combination of CD durations that will maximize the
accumulated value over six years. All interest rates are convertible semiannually.
Various combinations are analyzed below:
20
Chapter 2
8
4
4-year/2-year: 1000 (1.04 ) (1.03) = 1540.34.
All other accumulations involving shorter-term CDs are obviously inferior. The
maximum value is $1540.34.
28. Let the purchase price be R. The customer has two options:
One: Pay .9R in two months.
Two: Pay (1 .01X ) R immediately.
The customer will be indifferent if these two present values are equal. We have
(1 .01X ) R = .9 R (1.08 )
1 .01X = .9 (1.08 )
16
= .88853
and
.70 R = .75 R (1 + i )
.5
.70 (1 + i ) = .75
.5
and
2
.75
i=
1 = .1480, or 14.80%.
.70
30. At time 5 years
1000 (1 + i / 2 ) = X .
10
1000 (1 + i / 2 )
14
(1 + 2i / 4 )
14
= 1980.
We then have
(1 + i / 2 ) = 1.98
10
10 / 28
(1 + i / 2 ) = (1.98) = 1.276
28
Chapter 2
20
10
10
2 A (1.06 ) = B (1.08 )
which is two linear equations in two unknowns. Solving these simultaneous equations
gives:
A = 182.82 and B = 303.30 .
The answer then is
5
5
5
5
A (1.06 ) + B (1.08 ) = (182.82 )(1.06 ) + ( 303.30 )(1.08 )
= $690.30.
We then have
d=
1000 920
80
=
= .08.
1000
1000
X 1 12 (.08 ) = 288,
so that
288
= 300
.96
and the face amount has been reduced to
1000 300 = $700.
X=
22