UECM1404 Theory of Interest

Tutorial 8: Sinking Funds

1. John borrows 10,000 for 10 years and uses a sinking fund to repay the principal. The sinking
fund deposits earn an annual effective interest rate of 5%. The total required payment for
both the interest and sinking fund deposit at the end of each year is 1445.04. Calculate the
annual effective interest rate charged on the loan. …………............................. . Ans: 6.5%

2. Barbara borrowed 10,000 from a bank and agreed to make interest payments every 3
months on the loan at an annual effective rate of 8%. She will repay the principal at the end
of 5 years. At the same time the interest payment is made, Barbara also makes deposits of
X into a fund earning interest at a nominal annual rate of 6% convertible quarterly. At the
end of 5 years, Barbara has exactly 10,000 in the fund to repay the loan. Determine
Barbara's total payment every 3 months. ……………... …... . . . . . . . ……………Ans: 627

3. Joe repays a loan of 10,000 by establishing a sinking fund and making 20 equal payments
at the end of each year. The sinking fund earns 7% effective annually. Immediately after
the fifth payment, the yield on the sinking fund increases to 8% effective annually. At that
time Joe adjusts his sinking fund payment to so that the sinking fund will accumulate to
10,000 20 years after the original loan date. Determine ……………...... . . . . . Ans: 204.41

4. Kate borrows 10,000 for 10 years at an annual effective interest rate of 9%. At the end of
each year, she pays the interest on the loan and deposits the level amount necessary to repay
the principal to a sinking fund earning an annual effective interest rate of 8%. The total
payments made by Kate over the 10-year period is . Calculate . …………..Ans: 15,903

5. Howard wishes to borrow 1000. Lynn offers a loan at a 10.65% annually effective rate in
which would repay the loan with eight equal annually payments made at the end of each
year by the amortization method. Ann offers a loan in which the principal is to be repaid at
the end of eight years. In the meantime, 9% annual effective is to be paid on the loan, and
Howard is to accumulate the amount necessary to repay the loan by depositing eight annual
payments at the end of each year into a sinking fund. Calculate the interest rate the sinking
fund must earn so that Howard is indifferent between the two offers………….Ans: 5.76%

6. A 12–year loan of 8000 is to be repaid with payments to the lender of 800 at the end of each
year and deposits of X at the end of each year into a sinking fund. Interest on the loan is
charged at an 8% annual effective rate. The sinking fund annual effective interest rate is
4%. Calculate X. ……………………………………………………………....Ans: 330.34