Solutions Consolidated Feb 2023

Solutions to End of Chapter
Questions (Third Edition)

Calculator Settings
Many of the solutions below utilize the BA II Plus calculator, and those solutions are based
on the following assumptions:
 The calculation method is set to the algebraic operating system (AOS). If the
calculation method is currently set to the chain calculation method (Chn), then it
can be changed to the AOS method with the following key strokes:
[2nd] [FORMAT] ↓↓↓↓ [2nd] [SET] [2nd] [QUIT]
 The payments per year (P/Y) and compounding periods per year (C/Y) are set to 1.
Changing the P/Y setting to 1 will automatically change the C/Y setting to 1:
[2nd] [P/Y] 1 [ENTER] [2nd] [QUIT]
 The relevant worksheet register has been cleared prior to data entry. The
keystrokes to clear the registers are:
[2nd] [CLR TVM] to clear the time value of money worksheet
[2nd] [CLR WORK] to clear the other worksheets
 Unless stated otherwise, the calculator is set to treat payments as occurring at the
end of each period. To toggle the calculator between treating payments as
occurring at the beginning of each period or the end of each period, use the
following key strokes:
[2nd] [BGN] [2nd] [SET] [2nd] [QUIT]
If you take an actuarial exam, the exam administrator will reset your calculator prior to
the exam. This means that it will then revert to using the chain calculation method, and it
may change the settings for P/Y and C/Y. After it has been reset, you can easily change it
back to the settings shown above. If you would like to practice, you can reset the
calculator as follows:
[2nd] [RESET] [ENTER] [2nd] [QUIT]
Chapter 1: Setting the Stage

Solution 1.01
C Section 1.04, Terminology
Statement II is false. The current value could include the accumulated value of payments
that have occurred in the past.
Statement IV is false. A borrower receives funds now. The lender provides the funds.
Solution 1.02
E Section 1.05, Supply and Demand for Funds
The supply and demand curves can change over time for a variety of reasons, including
lifestyle decisions and demographic changes.
© ActuarialBrew.com 2022 Page 1

Chapter 2: Simple Interest and Discount
Solution 2.01
D Section 2.01, Simple Interest
Since the simple interest rate is expressed as an annual value, we use years as our unit of
time. 18 months is equal to 1.5 years, so the funds accumulate from time 1.5 to time 5,
which is 3.5 years. The accumulation function is based on the deposit being made at time
0, so we interpret t to be the time from the deposit until the valuation date:
AVt  PV0 (1  it )
AV3.5  10, 000(1  0.07  3.5)
AV3.5  12, 450
Solution 2.02
D Section 2.02, Simple Interest
The present value of $10,000 in 8 years is:
AVt 10, 000 10, 000
PV0     6, 410.26
1  it 1  0.07  8 1.56
Solution 2.03
A Section 2.02, Simple Discount
The present value of $10,000 in 8 years is:
PV0  AVt (1  dt )  10, 000(1  0.07  8)  10, 000(0.44)  4, 400
Solution 2.04
B Section 2.04, Simple Interest
Let’s assume that the amount due in 45 days is X. Larry will choose option 2 if it results
in having surplus funds after paying X at the end of 45 days. That is, he will choose option
2 if the accumulated value minus the amount due is greater than 0:
0.97 X
X 0
30
1 d
365
0.97
1  0
30
1 d
365
0.97
1
30
1 d
365
30
0.97  1  d
365
30
d  1  0.97
365
d  0.3650
The minimum value of d that will cause Larry to choose option 2 is 36.50%.

Chapter 2: Simple Interest and Discount Solutions to End of Chapter Questions
Solution 2.05
E Section 2.02, Simple Interest and Discount
The accumulated values are calculated below:
A  AV5  1, 000(1  0.05  5)  1, 250
900
B  AV5   1,200
1  0.05  5
900
C  AV6   1,184.21
1  0.04  6
D  AV4  1, 000(1  0.06  4)  1, 240
1, 000
E  AV8   1, 315.79
1  0.03  8
The highest accumulated value is Choice E.
Solution 2.06
C Section 2.03, Equivalent Simple Interest and Discount Rates
The accumulated values are equal at the end of t years:
100
100(1  0.05t ) 
1  0.04t
(1  0.05t )(1  0.04t )  1
1  0.05t  0.04t  0.002t 2  1
0.01t  0.002t 2  0
0.01  0.002t  0
t 5
Eric’s accumulated value at the end of 5 years is:
100(1  0.05t )  100(1  0.05  5)  125
Solution 2.07
A Section 2.03, Equivalent Simple Interest and Discount Rates
Let the amount of the initial loan be L. The accumulated values are equal at the end of t
years:
L
L(1  it ) 
1  dt
1
1  it 
1  dt
(1  it )(1  dt )  1
1  it  dt  idt 2  1
it  dt  idt 2  0
i  d  idt
i d
t 
id
Equation I is the only valid expression for t.

Solution 2.08
B Section 2.04, Equations of Value under Simple Interest
The amount of interest earned by Ann each year is:
800  0.06  48
Ann’s interest is twice the interest earned by Mike:
48  2  X  0.09
X  266.67
Solution 2.09
A Section 2.04, Equations of value under Simple Interest and Discount
We begin by noting that 0  x  0.10 and 0  T  10 implies that 0  xT  1 .
Let’s consider the possibility that Choice A is correct and Haley’s account value is certain
to be greater than Tyler’s account value. If Choice A is correct, then:
1
1, 000   1, 000(1  xT )
1  xT
1  (1  xT )(1  xT )
1  1  (xT )2
0   (xT )2
(xT )2  0
Since the square of xT is always greater than 0, the result above is consistent with Choice
A being true. Working backwards, we can put this in the form of a proof:
(xT )2  0
0   (xT )2
1  1  (xT )2
1  (1  xT )(1  xT )
1
1, 000   1, 000(1  xT )
1  xT
We’ve shown that Choice A is correct. Since Choice A precludes the other choices, the
other choices must be false.
Solution 2.10
C Section 2.04, Equations of value under Simple Interest and Discount
The accumulated value of the fund minus the accumulated value of the loan is:
X  1, 000 1  0.06t   1, 000(1  0.05t )1
To find the point at which X is maximized, we take the derivative of X:

dX
 1, 000(0.06)  1, 000(1)(1  0.05t )2 (0.05)
dt
50
 60 
(1  0.05t )2
Page 4 © ActuarialBrew.com 2022

We set the derivative equal to zero to find the local maximum:

50
0  60 
(1  0.05t )2
5
(1  0.05t )2 
6
5
1  0.05t  
6
5
0.05t  1 
6
5
1
6
t 
0.05
t  38.2574 or t  1.7426
The question tells us that t must be between zero and 10, so we consider the value of
1.7426. To determine whether it is a local maximum or a local minimum, we take the
second derivative of X and evaluate it at t = 1.7426:
dX 50
 60 
dt (1  0.05t )2
d2 X 50 5 5
 (2) (0.05)    6.5727
2 3 3
dt (1  0.05t ) (1  0.05t ) (1  0.05  1.7426)3
Since the second derivative is negative, there is a local maximum at 1.7426. The
maximum value of X within 10 years is:
X  1, 000 1  0.06t   1, 000(1  0.05t )1
 1, 000 1  0.06  1.7426   1, 000(1  0.05  1.7426)1
 1,104.55  1, 095.45  9.11

Chapter 3: Compound Interest and
Discount
Solution 3.01
D Section 3.01, Compound Interest
The number of years until the 1-year-old, 4-year-old, 6-year-old, and 9-year-old reach
the age of 17 are 16, 13, 11, and 8, respectively.
The number of years until the 1-year-old, 4-year-old, 6-year-old, and 9-year-old reach
the age of 22 are 21, 18, 16, and 13, respectively.
The present value of the payments matches Choice D:
A v16  v13  v11  v 8   B v 21  v18  v16  v13 
   
  A  Bv  v  v  v  v 
5 16 13 11 8
  
Solution 3.02
D Section 3.01, Compound Interest
Let P be the purchase price. The two offers have the same present value:
0.92P(1.07)9/12  P 1   X
100 

0.8745  1  X
100 
X  12.55
Solution 3.03
C Section 3.01, Compound Interest
The equation of value at the outset can be used to solve for i:
100  200v n  300v 2n  604.42v n  2
100  200  0.7  300  0.72  604.42  0.7v 2
0.9147  v 2
i  0.0456
Solution 3.04
E Section 3.01, Compound Interest
The equation of value at the outset can be used to solve for i:
100  200v n  300v 2n  604.42v n  2
100  200  0.7  300  0.72  604.42  0.7v 2
0.9147  v 2
i  0.045594

Chapter 3: Compound Interest and Discount Solutions to End of Chapter Questions
We now solve for n:

v n  0.7
n
 1 
   0.7
 1.045594 
n   ln(1.045594)  ln(0.70)
n  8.0
Solution 3.05
B Section 3.01, Compound Interest
Since the amount of interest earned in Wanda’s account during the 11th year is equal to
the amount of interest earned in Claire’s account during the 15th year, the amount in
Wanda’s account at the end of the 10th year must be equal to the amount in Claire’s
account at the end of the 14th year:
1, 000(1  i )10  700(1  i )14
10
 (1  i )4
7
i  0.09327
The interest earned in Wanda’s account in the 11th year is:
X  1, 000(1  i )10 i  1, 000(1.09327)10  0.09327  227.50
Solution 3.06
E Section 3.01, Simple Interest & Compound Interest
The interest earned in Bonnie’s account is the product of the original deposit, the length of
time elapsed, and the simple interest rate. The interest earned in Bonnie’s account during
the 7th year is:
1, 800  1  i
The interest in earned in Clyde’s account during the 7th year is the balance after 6 years
times the annual effective interest rate:
6
1, 000 1  i   i
Setting Bonnie’s interest earned during the 7th year equal to Clyde’s interest earned
during the 7th year allows us to solve for i:
6
1, 800  1  i  1, 000 1  i   i
6
1, 800  1, 000 1  i 
6
1, 800  1, 000 1  i 
i  10.29%

Solution 3.07
A Section 3.01, Compound Interest
Equating the present value of the single payment with the present value of the set of
three payments allows us to solve for T:
1,553.50 300 500 700
  
T /12 1/12 1.5
1.04 1.04 1.04 1.042
1,553.50
 1, 417.6434
1.04T /12
1.09583  1.04T /12
T
ln(1.09583)   ln(1.04)
12
T  27.9998
Solution 3.08
C Section 3.01, Compound Interest
Let’s use B1 and B2 to denote the balances in the account as of July 1, 2013. We are
given the balance in account #1 was three times the balance in account #2:
B1  3B2
Nine years later the balance is 150,000:
B1(1.03)9  B2 (1.05)9  150, 000
3B2 (1.03)9  B2 (1.05)9  150, 000
B2  27, 444.1395
The sum of the two accounts on July 1, 2013 was:
B1  B2  3B2  B2  4B2  4  27, 444.1395  109, 776.56
Solution 3.09
A Section 3.01, Compound Interest
There is no need to calculate the values of i or t.
Using the equality of the first and third payment streams, we can find the value of v:
12, 000v12  8, 000
1/12
 8 
v  
 12 
v  0.9668
Using the equality of the second and third payment streams, we can find v t :
3, 000v t  63, 000v 2t  8, 000
63v 2t  3v t  8  0
(21v t  8)(3v t  1)  0
8 1
vt   or vt 
21 3
Since the discount factor must be positive, we have:
1
vt 
3

The present value of 6,000 at time (t +1) is:

1
6, 000v t 1  6, 000  v t  v  6, 000   0.9668  1, 933.55
3
Solution 3.10
B Section 3.01, Compound Interest
Jill’s accumulated amount is equal to Tom’s accumulated amount at the end of 15 years:
40 1  0.05  15  20 1  0.05  (15  6)  40(1.04)15  n  20(1.04)15 2n
40  40  0.05  15  20  20  0.05  9  40(1.04)15  n  20(1.04)15 2n
99  40(1.04)15  n  20(1.04)15 2n
54.9712  40(1.04)n  20(1.04)2n
54.9712(1.04)2n  40(1.04)n  20
54.9712(1.04)2n  40(1.04)n  20  0
Let’s use x  1.04n and use the quadratic formula to solve for x:
54.9712 x 2  40 x  20  0
40  (40)2  4(54.9712)(20)
x 
2(54.9712)
x  0.34059 or x  1.06824
We use the positive value of x to solve for n:
x  1.06824
1.04n  1.06824
n ln(1.04)  ln(1.06824)
n  1.6831
Solution 3.11
C Section 3.03, Compound Discount
The present value of the payments is:
PV0  10, 000(1  0.065)3  15, 000(1  0.065)5  18, 892.88
Solution 3.12
E Section 3.03, Compound Discount
The accumulated value of the payments is:
8, 000 2, 000
AV6    15, 038.56
6
(1  0.07) (1  0.07)6 2
Solution 3.13
B Section 3.03, Compound Interest and Discount
The accumulated value of the deposit is:
AV4.5  2, 000(1.08)4.5  2, 827.72

The present value of the payment is:

PV0  2, 827.72(1  0.05)4.5  2, 244.88
Solution 3.14
B Section 3.03, Compound Discount
The amount of interest earned in each fund is the accumulated value of the fund minus
the original value of the fund:
12
X 1  X
X (1.03)12  X  
3  1  d  3
12
1 1  1
(1.03)12  1  
3  1  d  3
12
 1 
1.2773    1
1  d 
1
1.07099 
1d
d  0.06628
Solution 3.15
B Section 3.03, Compound Discount
There is no need to calculate the value of d.
The present values of the two sets of payments are equal, allowing us to solve for the
one-year discount factor:
169  169v  196v 2  196v 3
169(1  v )  196v 2 (1  v )
169  196v 2
169
v 
196
13
v 
14
The present value of the first set of payments is:
13
K  169  169v  169  169   325.93
14
Solution 3.16
E Section 3.04, Equivalent Compound Interest and Discount
A is true:
d d 1 d
i(1  i )  (1  i )   
1d 1  d v v  vd
B is true:
2 2
 d  d  d2
i2       2
1  d  v  v
C is true:
id  i(1  v )  i  iv  i  d

D is true:
1  1 v iv 2 1  v  iv 2
i  d  i  iv    1   iv    
v  v v v v
E is false:
i  d  i  iv  i(1  v )
i(1  v )  i(1  v )
Solution 3.17
D Section 3.05, Interest Rate Conversion
The annual effective interest rate is:
12
 0.12 
i  1    1  1.0112  1  0.1268
 12 
Solution 3.18
E Section 3.05, Interest Rate Conversion
The two-year effective interest rate is found below:
m p
 i(m)   i( p) 
1    1  
 m   p 
 
1/2 12
 i(1/2)   0.12 
1    1  
 1 / 2   12 

 i(1/2)  24
1    1.01
 1 / 2 

i(1/2)
 0.2697
1/2
Solution 3.19
A Section 3.05, Simple Interest & Compound Interest
The interest earned in Patty’s account is the product of the original deposit, the length of
time elapsed, and the simple interest rate. The interest earned in Patty’s account during
the last 3 months of the 7th year is:
1, 800  0.25  i
We would normally write the nominal interest rate compounded quarterly as i(4) , but
since this question calls it i, we do likewise. The interest earned in Sally’s account is the
balance after 6 years and 9 months, which is equal to 27 quarters, times the quarterly
effective interest rate:
27
 i  i
1, 000  1   
 4  4

Setting Patty’s interest equal to Sally’s interest allows us to solve for i:

27
 i  i
1, 800  0.25  i  1, 000  1   
 4  4
27
 i 
1, 800  1, 000  1  
 4
i  8.80%
Solution 3.20
C Section 3.05, Interest Rate Conversions
The quarterly effective interest rate can be converted to the monthly effective interest
rate:
i(4) 0.12
  0.03
4 4
There are 3 months in a quarter, so the monthly accumulation factor is the cube root of
the quarterly accumulation factor:
i(12) 1
1  1.033
12
i(12)
1  1.009902
12
i(12)  0.1188
Solution 3.21
D Section 3.05, Nominal Interest Rates
1012 1412
 i(12)   i(12) 
1, 000  1    700 1  
 12   12 
 
412
10  i(12) 
 1  
7  12 

12
 i(12) 
1    1.09327
 12 


1012  12 
i(12)   1  i
(12) 
X  1, 000 1     1  1, 000(1.09327)10  0.09327
 12   12  
  
 227.50
Alternative Solution: Since the two accounts earn the same effective interest rate
compounded monthly, they must also earn the same equivalent annual effective interest
rate. Therefore, as shown below, we can answer the question without reference to the
monthly effective interest rate.

1, 000(1  i )10  700(1  i )14
10
 (1  i )4
7
i  0.09327
X  1, 000(1  i )10 i  1, 000(1.09327)10  0.09327  227.50
Solution 3.22
Although we usually use i to denote an annual effective interest rate, this question uses i
to denote the annual interest rate that is compounded semiannually. We would usually
use i(2) to denote this interest rate.
Sam’s interest is based on the balance at the end of 13 6-month periods, and Dennis’
interest is based on the initial deposit:
13
 i i i
D  1     2D 
 2 2 2
13
 i
1  2   2
 
i  10.95%
Solution 3.23
E Section 3.05, Nominal Interest Rates
(2)
Let i be the annual interest rate charged to Adam.
At the outset, the present value of Heidi’s loan is equal to the present value of Adam’s
loan:
1, 400 2, 000

40 40
1  i(2)  1  i(2) 
 22   2 
 
 1  i(2) 
 1, 400 
1/40  4 
 
 2, 000 
   i(2) 
1  2 
 
1  i 
(2)
 4 
0.7 1/40
 
 1  i(2) 
 2 

0.71/40  0.71/40  0.5i(2)  1  0.25i(2)
0.7 1/40

 0.5  0.25 i(2)  1  0.71/40
0.245561i(2)  0.008877
i(2)  0.03615

We can now find the present value of Heidi’s loan:

1, 400 1, 400
L   976.86
 
40 40
1  i(2)  1 0.03615
 4  4

Solution 3.24
Interest is credited only at the end of each interest conversion period, so Michelle receives
interest only every 3 months. Therefore, the moment at which Michelle’s account is at
least double the amount in Lucy’s account will occur on some multiple of 3 months.
Let t be the number of 3-month periods until Michelle’s account is at least double the
amount in Lucy’s account. We need to find the minimum integer value of t that satisfies
the following:
t 3t
 0.12   0.06 
100   1    100  2  1  
 4   12 
1.03t  2 1.005
3t
t ln(1.03)  ln(2)  3t ln(1.005)

t  47.4883
The smallest integer that satisfies the equation above is t = 48. The number of months in
48 three-month intervals is:
48  3  144
Solution 3.25
B Section 3.05, Nominal Interest Rates
The monthly effective interest rate is:
0.09
 0.0075
12
The equation of value that equates the value of the deposits with $5,900 six years from
today is:
1,500  1.007572  n  3, 000  1.007572 2n  5, 900
1,500  1.0075n  3, 000  1.00752n  5, 900  1.007572
3, 000 X 2  1,500 X  3, 445.1494  0 where: X  1.0075n
We can use the quadratic formula to solve for X:
1,500  1,5002  4(3, 000)(3, 445.1494)

X 
2  3, 000
X  1.3504 or X  0.8504
Using the positive value of X, we have the maximum possible value of n:
X  1.0075n
0.8504  1.0075n
n  21.6872
Since n must be less than or equal to 21.6872, the maximum integral value of n is 21.

Solution 3.26
D Section 3.06, Nominal Interest and Discount Rates
The accumulated value of the deposit is:
4.52
 0.08  9
AV4.5  2, 000 1    2, 000 1.04   2, 846.62
 2 
The present value of the payment is:
4.512
 0.05  54
PV0  2, 846.62 1    2, 846.62  0.9958   2, 272.01
 12 
Solution 3.27
D Section 3.06, Nominal Discount Rates
The monthly effective discount rate is:
0.09
 0.0075
12
The equation of value that equates the value of the deposits with $5,900 six years from
today is:
72  n 72  2n
 1   1 
1,500     3,100     5, 900
 1  0.0075   1  0.0075 
1,500  0.9925n 72  3,100  0.99252n 72  5, 900
1,500  0.9925n  3,100  0.99252n  5, 900  0.992572
3,100 X 2  1,500 X  3, 431.2244  0 where: X  0.9925n
We can use the quadratic formula to solve for X:
1,500  1,5002  4(3,100)(3, 431.2244)

X 
2  3,100
X  1.3215 or X  0.8376
Using the positive value of X, we have the maximum possible value of n:
X  0.9925n
0.8376  0.9925n
n  23.5412
Since n must be less than or equal to 23.5412, the maximum integral value of n is 23.
Solution 3.28
The monthly accumulation factor is equal to the inverse of the monthly discount factor:
1
i(12)  d(12) 
1  1  
12  12 

1
i(12)  0.22 
1  1  
12  12 
i(12)  0.2241

Solution 3.29
The interest rate and the discount rate produce the same one-year accrual factor:
m p
 i(m)   d( p) 
1    1  
 m   p 
   
12 4
 0.14   d(4) 
1    1  
 12   4 
 
3
 0.14  d(4)
1   1
 12  4
d(4)  0.1368
Solution 3.30
B Section 3.07, Nominal Discount Rates
We can use the ratio of A to B to find d:
16
A  51 
 
B  52 
 
4 4
50 1  d4  51 
16
 
50 1  d2 
82
 52 
1  d2   51
1  d4  52
52  26d  51  12.75d
1  13.25d
d  0.07457
The value of d convertible quarterly is equivalent to an annual effective interest rate of i:
4
 d
1   1 i
 4
4
 0.07547 
1   1 i
 4 
i  0.0792

Chapter 4: Constant Force of Interest
Solution 4.01
B Section 4.02, Force of Interest
The force of interest is:
r  ln(1.080)  0.07696
Solution 4.02
A Section 4.02, Force of Interest
 0.10  
12

r  ln 1     0.09959
 12  
 
Solution 4.03
C Section 4.02, Force of Interest
 0.09  
4
r  ln 1     0.09103
 4  
 
Solution 4.04
r  ln 1  0.01
12 
 0.1206
 
Solution 4.05
 1/2 
 0.11  
r  ln  1    0.09943
 1 
 2  
 
Solution 4.06
Section 4.02, Force of Interest
a. The annual effective interest rate is:
i  e0.06  1  0.06184
b. The monthly effective interest rate is:
i(12)
 e0.06 /12  1  0.00501
12

Chapter 4: Constant Force of Interest Solutions to End of Chapter Questions
c. The annual interest rate compounded monthly is:
 
i(12)  12 e0.06 /12  1  12  0.00501  0.06015
d. The annual effective discount rate is:

d  1  e 0.06  0.05824
e. The quarterly effective discount rate is:
d(4)
 1  e 0.06 /4  0.01489
4
e. The annual discount rate convertible quarterly is:
 
d(4)  4 1  e 0.06 /4  4  0.01489  0.05955
Solution 4.07
The present value is:
3, 000e 0.072  8, 000e0.075  10, 000e 0.077
 3, 000  0.8694  8, 000  0.7047  10, 000  0.6126
 14, 371.84
Solution 4.08
D Section 4.02, Force of Interest
The balance at the end of 10 years is:
2, 000e0.0710  1,500e0.076  8, 000e0.07 4
 2, 000  2.0138  1,500  1.5220  8, 000  1.3231
 12, 329.60
Solution 4.09
E Section 4.02, Force of Interest
The original force of interest is:
 0.07  
4
r  ln 1     0.06939
 4  
 
One half of the original force of interest is:
0.5  0.06939  0.03470
The new annual interest rate compounded quarterly is:
i(4)  4  (e0.034700.25  1)  0.0348

Solution 4.10
The equation of value at the outset can be used to solve for r:
100  200v n  300v 2n  604.42v n  2
100  200  0.7  300  0.72  604.42  0.7v 2
0.9147  v 2
1  i  1.04559
ln(1  i )  0.0446
Solution 4.11
C Section 4.02, Force of Interest
The equation of value at the outset can be used to solve for v n :
100  200v n  300v 2n  600v n
300v 2n  400v n  100  0
3v 2n  4v n  1  0
(3v n  1)(v n  1)  0
1
vn  1 or vn 
3
The annual force of interest is greater than zero, so v n must be 1/3:
1
vn 
3
1
e0.1221n 
3
1
0.1221n  ln  
3
n  9.00
Solution 4.12
For a given force of interest, the equivalent nominal interest rate falls as its compounding
frequency increases. The expression in Choice E can be rewritten as:
i(1/2)  i(1)
Increasing the compounding frequency from every other year to every year will result in a
higher force of interest unless the interest rate with the higher compounding frequency is
lower than the interest rate with the lower compounding frequency. Therefore, Choice E
is false.

Solution 4.13
The number of quarters in 12 years and 1 month is:

4  12  1
12   48.3333
The equation of value at the end of 12 years and 1 month can be used to solve for the
force of interest:

200  1 
0.075 
48.3333
 220e

  12  1
12 
 4 
490.8684  220e12.0833
2.2312  e12.0833
ln(2.2312)  12.0833
0.8025  12.0833
  0.06642
Solution 4.14
At the end of 5 years the amount in Suzie’s account is:
200(1  5  0.05)  250
The amount in both accounts is the same at the end of 5 years:
250  220e5
ln(250)  ln(220)  5
  0.02557
Solution 4.15
D Section 4.02, Force of Interest
The derivative of the force of interest with respect to the annual effective interest rate is:
d d 1
  ln(1  i )  v
di di 1 i
The derivative of the annual effective interest rate with respect to the annual effective
discount rate is:
d d  d  (1  d )  1  d  (1) (1  d )  d 1 1
i       
2 2 2
dd dd  1  d  (1  d ) (1  d ) (1  d ) v2
The product is:
d   d  1 1
 di     dd i  v 
2
  1+i
v
    v

Chapter 5: Varying Rates
Solution 5.01
A Section 5.01, Varying Compound Interest
1 4 1.512
1.5  0.08   0.06 
PV0  100 1.07  1   1    76.3018
 4   12 
Solution 5.02
C Section 5.01, Varying Compound Interest
The equation of value can be used to find the level equivalent interest rate:
8
1.5 4 18
 i(2) 
Deposit  (1.07) (1.02) (1.005)  Deposit  1  
 2 

8
1.5 4 18
 i(2) 
(1.07) (1.02) (1.005)  1  
 2 

i(2)  0.0688
Solution 5.03
B Section 5.02, Varying Discount Rates
1 4 1.512
1.5  0.08   0.06 
PV0  100 1  0.07  1   1    75.5865
 4   12 
Solution 5.04
The accumulated value is:
1.5
100  0.93 0.984 0.99518  50 0.982 0.99518
 132.2988  56.9774  189.2761
Solution 5.05
The equation of value at time 5 can be used to solve for d:
36 2
6  1   1 
2  100(1.10)2 1.04   150    
 0.99  1  d 
2
 1 
306.2072  215.3894  
1  d 
d  0.1613

Chapter 5: Varying Rates Solutions to End of Chapter Questions
Solution 5.06
A Section 5.03, Varying Force of Interest
PV0  100  e 1.50.07e 0.08e1.50.06  100  e0.275  75.9572
Solution 5.07
D Section 5.03, Varying Force of Interest
100  e1.50.07e0.08e1.50.06  50  e0.50.08e1.50.06
 100  e0.275  50  e0.13  188.5945
Solution 5.08
Section 5.03, Varying Force of Interest
The accumulated value function and its derivative are:
AVt  D  (1  0.05t )
d  AVt 
 0.05D
dt
The force of interest at time t is:
d  AVt 
dt 0.05D 0.05
rt   
AVt D  (1  0.05t ) 1  0.05t
0.05
a. r1   0.04979
1
1  0.05  12
12
0.05
b. r1   0.04762
1  0.05  1
0.05
c. r5   0.04000
1  0.05  5
0.05
d. r10   0.03333
1  0.05  10
Solution 5.09
Section 5.03, Varying Force of Interest
The accumulated value function and its derivative are:
AVt  D  (1  0.05t )1
d  AVt 
 D  (1  0.05t )2 (0.05)  0.05D  (1  0.05t )2
dt
The force of interest at time t is:
d  AVt 
dt 0.05D  (1  0.05t )2 0.05
rt   
AVt 1 1  0.05t
D  (1  0.05t )
0.05
a. r1   0.05021
1
1  0.05  12
12

0.05
b. r1   0.05263
1  0.05  1
0.05
c. r5   0.06667
1  0.05  5
0.05
d. r10   0.10000
1  0.05  10
Solution 5.10
C Section 5.03, Varying Force of Interest
The present value at time 5 of the 12,000 payment is:
8 8 1 8
PV5  AV8e 5 s  12, 000  e 5 2  s
 r ds  ds  ln(2  s)
 12, 000  e 5
7
 12, 000  eln(7)ln(10)  12, 000   8, 400
10
The equation of value at time 5 can be used to solve for X:
5, 000(1.05)(5 0)  X (1.05)(5 2)  8, 400
X  1, 743.74
Solution 5.11
B Section 5.03, Varying Force of Interest
The force of interest at time t for Fund X is:
d  AVt 
dt 0.5
rtX  
AVt 1  0.5t
The force of interest at time t for Fund Y is:
d  AVt 
dt t
rtY  
AVt 1  0.5t 2
Setting the two equal allows us to determine the time at which the two forces of interest
are equal:
rtX  rtY
0.5 t

1  0.5t 1  0.5t 2
0.5  0.25t 2  t  0.5t 2
0  0.25t 2  t  0.50
We use the quadratic formula to solve for t:
1  12  4(0.25)(0.5)
t 
2  0.25
t  4.4495 or t  0.4495
Discarding the negative solution, we have:
t  0.4495

Solution 5.12
A Section 5.03, Varying Force of Interest
Since X(0) and Y(0) are constants and X(0) = Y(0), the answer to this question does not
depend on their value. For convenience, we assume that both are equal to 1:
X (0)  Y (0)  1
The accumulated value in Fund X at time t is:
t t 1  1 t 
t ln
 ds 
X (t )  AVt  e 0 s  e 0 1 s
r ds ln(1 s)  1 
e 0  eln(1 t )ln(1)  e 1t
The accumulated value in Fund Y at time t is:
t 10s
0 t ds
Y (t )  AVt  e 0 s  e 15s
r ds 2
Let’s use the following substitution:

u  1  5s2
du  10sds
The accumulated value in Fund Y at time t can now be written as:
 15t 2 
t 10s s t 1 s t
ln 
0 2
ds
s 0 u du ln(u)
s t ln(15s2 ) 2  1 
Y (t )  e 15s e  e s 0 e s 0  eln(15t )ln(1)  e  
 1  5t 2
We can find the maximum of H(t ) by setting its derivative equal to zero:
H(t )  X (t )  Y (t )
H(t )  1  t  (1  5t 2 )
H '(t )  1  10t
1  10t  0
t  0.10
For the sake of thoroughness, we note that the second derivative of H(t ) is negative at
t  0.1 , indicating that H(0.1) is a maximum:
H ''(t )  10
Solution 5.13
The equation of value is:
5
1, 000e 0
rs ds
 1, 000(1  i )5
5 1
0 ds
3(1 s)3
e  (1  i )5
To evaluate the integral, let’s use the following substitution:
u  (1  s)
du  ds

The integral is:

5 s 5 s 5 s 5
1 1 3  1 u 2   1 1 
 3(1  s)3
ds 
3 
u du       
2

 3 2  s 0  6 (1  s)  s 0
0 s 0
1  1 
   1  0.16204
6  36 
We can now use the equation of value to solve for i:
5 1
0 ds
3(1 s)3
e  (1  i )5
e0.16204  (1  i )5
1.17590  (1  i )5
i  0.032938
Solution 5.14
The accumulated value in Fund B at time t is:
t
AVt  e 0 s
r ds
Let’s evaluate the integral in the expression above:

t t t
2s3  6s 2s(s2  3) 2s
 s4  6s2  9 ds   2
(s  3) 2
ds   (s2  3) ds
0 0 0
Let’s use the following substitution:

u  s2  3
du  2sds
The integral is:
t s t  t2  3 
2s 1 s t t
 (s2  3) ds   u
du  ln(u)
s  0
 ln(s2  3)  ln(t 2  3)  ln(3)  ln 
0  3 



0 s 0
The accumulated value of Fund B at time t is:

t
t2  3
AVt  e 0 s 
r
3
At time 1, the accumulated value in Fund B is equal to the accumulated value in Fund A:
t2  3
 1  it when t  1
3
12  3
 1  i 1
3
4
1i
3
1
i 
3

Let H(t ) be the difference between Fund A and Fund B. We can find the maximum of
H(t ) by setting its derivative equal to zero:
t2  3
H(t )  1  it 
3
t t2  3
H(t )  1  
3 3
1 2t
H '(t )  
3 3
1 2t
 0
3 3
1  2t  0
2t  1
t  0.5
For the sake of thoroughness, we note that the second derivative of H(t ) is negative at
t  0.5 , indicating that H(0.5) is a maximum:
2
H ''(t )  
3
Solution 5.15
E Section 5.03, Varying Force of Interest
The integral of the force of interest from time 4 to time 8 is:
8
8 8  t3 t2   83 82   43 42  
4 t dt  4
2
0.001(t  t )dt  0.001     0.001     
 3 2    3 2   3 2 
 4    
 0.001 138.6667  13.3333  0.1253
The accumulated value at time 8 is:
8
100  e0.054  e 4
t dt
 100  e0.20  e0.1253  138.45
Solution 5.16
The integral of the force of interest from time 6 to time 10 is:
10
10 10  t3 t2 
6 6
2
t dt  0.002(t  t )dt  0.002   
 3 2 
 6
 103 102   63 62  
 0.002        0.002 383.3333  90
 3 2   3 2  

 0.5867
The present value at time 2 is:
10
100  e 6 t  e0.02(6 2)  100  e 0.5867  e 0.08  51.3417
  dt

Solution 5.17
The interest accumulation factors must be the same for Marcia and Jan over the course of
5 years. The interest accumulation factor for Jan is:
 5 1   ln(K  0.20t ) 5 
exp 

0 K  0.20t
dt   exp 
  0.20
  exp 5  ln(K  1)  5  ln(K )
0 

5
  K  1   K  1 
 exp 5  ln     
  K   K 
The interest accumulation factor for Jan is equal to the interest accumulation factor for
Marcia:
5 5
 K  1  K 
   1  
 K   36 
K 1 K
1
K 36
K2
K 1  K 
36
K2
1
36
K 6
Jan’s accumulated value at the end of 5 years is:
5 5
 K  1 7
100    100    216.14
 K  6
Solution 5.18
B Section 5.03, Varying Force of Interest
At time 4, before the deposit of X, the value of the fund is:
4
4 t3 t4
0 2,000 dt 8,000
100e  100e 0  100e0.032
The accumulation factor from time 4 to time 8 is:
8
8 t3 t4
4 2,000 dt 8,000
e e 4  e0.512  0.032  e0.48
The interest earned from time 4 to time 8 is equal to X:
100e 0.032

 X e0.48  1  X
 
100e 0.032
 X  0.6161  X
63.6108  0.3839 X
X  165.6851

Solution 5.19
The equation of value is:
t
De 0
 s ds
 3D
 t s2 
exp 
 0 4 s

3
ds   3

t 2
0 4s s3 ds  ln3
u  4  s3
du  3s2ds
The integral is:
s t

t
s2
0 4  s3
ds 
1
3 
t
1
0 4  s3
3s2ds 
1
3
s t
s 0
1
u
1
du   ln u
3
s t
s  0
1

  ln 4  s3
3
 s 0
 4  t3 

1 
3 

 ln 4  t 3  1
 ln(4)   ln 
 3  4 



We can now solve for t:
t 2
0 4s s3 ds  ln3
 4  t3 
1  ln    ln3
3  4 
 
1/3
 4  t3 
  3
 4 
 
t  4.7027
Solution 5.20
E Section 5.03, Varying Force of Interest
8
800e 0 s
  ds

s3
u  4
180
s2
du  ds
60
The integral is:
s2
t t 1 s2
s 5 1 s 5
0 4  0 4  s 0 u du  0.5  ln u s 0
120
ds  0.5 ds  0.5
s 3
s 3 60
180 180
s 5
 0.5  ln  4  s 

3
180  s 0  180   
 0.5  ln 4  125  ln(4)  ln 1.0833


8
800
800e 0 s  800e  ln(1.0833) 
  ds
 738.46
1.0833
Solution 5.21
E Section 5.04, Mix of Varying Rates
12 4
 0.06   0.07  0.10
100 1   1   e  100(0.995)12 (1.0175)4 e0.10  125.80
 12   4 
Solution 5.22
A Section 5.04, Mix of Varying Rates
12 4
 0.06   0.07 
100 1   1   e 0.10  100(0.995)12 (1.0175)4 e0.10  79.49
 12   4 
Solution 5.23
C Section 5.04, Mix of Varying Rates
The equation of value at the end of 6 years can be used to find d:
22
4  d
500 1  d  1    767
 2
4
 d 4
1    1.534 1  d 
 2
1  0.5d  1.1129 1  d 
1.6129d  0.1129
d  0.07
Solution 5.24
C Section 5.04, Mix of Varying Rates
The equation of value at the end of 20 years can be used to find d:
27 1312 1012
 d  0.07   0.07 
100  1   1    50  1    500
 2  12   12 
14 1312
 d  0.07 
100  1   1    399.5169
 2  12 
14
 d
1    1.6124
 2
d  0.0671

Solution 5.25
C Section 5.05, Accumulation Function
The accumulation function at the end of 15 years is:
a(15)  1  0.04  15  0.002  152  2.05
The accumulated value of 1 at the end of 15 years is equal to the accumulated value
found using the equivalent discount rate:
1
a(15) 
(1  d )15
1
2.05 
(1  d )15
0.9533  1  d
d  0.04673
Solution 5.26
C Section 5.05, Amount Function
The amount function at time 0 and at the end of 15 years has the following values:
A(0)  1, 000
A(15)  2  152  40  15  1, 000  2, 050
The accumulation function at time 15 is therefore:
A(15) 2, 050
a(15)    2.05
A(0) 1, 000
1, 000 1, 000
PV0    487.80
a(15) 2.05
Solution 5.27
A Section 5.05, Amount Function
The value of Z is 500:
A(0)  X  02  Y  0  Z
500  Z
We have 2 equations that can be solved to find X and Y:
521  X  Y  500
596  16 X  4Y  500
Multiplying the first equation by 4 and subtracting the second equation, we find X:
521  4  596  (4  16)X  (4  4)Y  4  500  500
1, 488  12 X  1,500
X 1
Using the values of X and Z, we can find Y:
A(t )  Xt 2  Yt  Z
A(1)  1  12  Y  1  500
521  1  Y  500
Y  20

The accumulation function is:

A(t ) t 2  20t  500
a(t )    0.002t 2  0.04t  1
A(0) 500
The accumulated value at time 5 of 400 deposited at time 0 is:
AV5  400  a(5)  400   0.002  25  0.04  5  1  500

Chapter 6: Level Annuities Payable Once
per Time Unit
Solution 6.01
E Section 6.02, Annuity-Immediate
The equation of value at time n can be used to solve for n:
1, 000sn 0.05  2, 061.34a10 0.05
1.05n  1 1  1.0510
1, 000   2, 061.34 
0.05 0.05
20, 000(1.05n  1)  2, 061.34  7.7217
1.05n  1  0.7959
n  ln(1.05)  ln(1.7959)
n  12
The BA-II Plus can be used to solve the problem as follows:
10 [N] 5 [I/Y] 2,061.34 [PMT] [CPT] [PV]
Result is 15,917.12.
[FV] 0 [PV] 1,000 [PMT] [CPT] [N]
Solution is 12.
Solution 6.02
B Section 6.02, Annuity-Immediate
The equation of value at time 0 can be used to find X:
2, 000a15 0.08  Xa5 0.08
1  v15 1  v5
2, 000   X
0.08 0.08
2, 000(1  1.0815 )  X (1  1.085 )
X  4, 287.55
15 [N] 8 [I/Y] 2,000 [PMT] [CPT] [PV]
Result is 17,118.96.
5 [N] [CPT] [PMT]
Solution is 4,287.55.
Solution 6.03
A Section 6.02, Annuity-Immediate
Xs5 0.08  1.0810  10, 000a30 0.08
1.085  1 1  1.0830
X  1.0810  10, 000 
0.08 0.08
X (1.085  1)  1.0810  10, 000(1  1.0830 )
X  8, 888.51

Chapter 6: Level Annuities Payable Once per Time Unit Solutions to End of Chapter Questions

30 [N] 8 [I/Y] 10,000 [PMT] [CPT] [PV]
Result is 112,577.83.
[] 1.08 [yx] 10 [=] [FV]
5 [N] 0 [PV] [CPT] [PMT]
Solution 6.04
D Section 6.02, Annuity-Immediate
The purchase price of the new car is equal to the down payment plus the present value of
the monthly payments:
 
60
1 1 0.07
12
X  5, 000  500a  5, 000  500 
60 0.07 0.07
12
12
 5, 000  500  50.5020  30, 251.00
60 [N] 7 [] 12 [=] [I/Y] 500 [PMT] [CPT] [PV]
Result is 25,251.99.
[+/-] [+] 5,000 [=]
Solution 6.05
The equation of value at time 0 can be used to solve for i:
1,700a5  1, 000a10
1  v 5 1  v10
1.7  
i i
1.7  (1  v 5 )  1  v10
1.7  (1  v 5 )  (1  v 5 )(1  v 5 )
1.7  1  v 5
i  0.0739
Solution 6.06
C Section 6.02, Annuity-Immediate
The equation of value at time 0 can be used to solve for i:
100
 114.16a20
i
100 1  v 20
 114.16 
i i
0.8760  1  v 20
v  0.9009
i  0.11

Solution 6.07
The ratio of the given values can be used to solve for v 3n :
1v 6n
a6n i

a3n 1v 3n
i
39.3119 1  v 6n

26.0000 1  v 3n
39.3119
 1  v 3n
26.0000
v 3n  0.5120
An annuity that pays for 9n units of time has the same present value as an annuity that
pays for 3n units of time plus the present value of a deferred annuity that pays for 6n
units of time:
a9n  a3n  v 3n a6n  26.0000  0.5120  39.3119  46.1275
Solution 6.08
0.22
 0.01833
12
Let’s use months as our unit of time. The extra payment occurs 5 months after the loan
begins:
15, 000  800an  1,200v 5
1,200
15, 000  800an 
1.018335
13, 904.1996  800an
17.3802  an
1  1.01833n
17.3802 
0.01833
1.01833n  0.6814
n  ln(1.01833)  ln(0.6814)
n  21.1182
Therefore, the last full payment occurs 21 months after the loan begins, which is October
1, 2023.
We can use the BA II Plus to find the value of n:
0.22 [] 12 [+] 1 [=] [STO] 1 [] 1 [=] [] 100 [=] [I/Y]
15,000 [] 1,200 [] [RCL] 1 [yx] 5 [=]
(Result is 13,904.1996)
[PV] 800 [+/-] [PMT]
[CPT] [N]
Result is 21.1182.

Solution 6.09
Choice B is the correct answer, because the expression in Choice B is not a valid
expression for an . Let’s consider each choice.
Choice A is valid:
vn  1 1  vn 1  vn 1  vn 1  vn
     an
(v  1)(1  i ) (1  v )(1  i ) d(1  i ) i  (1  i ) i
1 i
Choice B is not valid:
(1  i )n  1 n 1  v n 1  vn
v   (1  i )   (1  i )  an
1v d i
Choice C is valid:
(1  i )n  1 1  vn
sn  (1  iv )n  sn  (1  d )n  sn  v n   vn   an
i i
Choice D is valid:
 1  vn   1   1  vn   1  1  vn
    (1  i )    an
 iv   1  i   i  1  i  i
   
Choice E is valid:
1  v  v 2    v n 1
1i
 
 v  1  v  v 2    v n 1  v  v 2  v 3    v n  an
Solution 6.10
Another way to describe the deposits is to say that deposits of 87 are made for 3n years
and additional deposits of 87 are made during the first n years.
The equation of value at time 3n can be used to solve for i:
36, 419.74  87s3n  87sn  (1  i )2n
(1  i )3n  1 (1  i )n  1
36, 419.74  87   87   (1  i )2n
i i
36, 419.74i  87  (1  i )3n  1  87  (1  i )n  1  (1  i )2n
   
36, 419.74i  87  27  1  87  3  1  9
i  0.1051
Solution 6.11
The equation of value at the end of 17 years can be used to solve for X:
Xs7 0.04  (1.08)10  8, 000
1.047  1
X  3, 705.5479
0.04
X  7.8993  3, 705.5479
X  469.16


8,000 [] 1.08 [yx] 10 [=] [FV]
7 [N] 4 [I/Y] [CPT] [PMT]
Result is 469.16. Answer is 469.16.
Solution 6.12
Setting the present values of the first two annuities equal to one another gives us an
equation in terms of i:
1
 a40 i
0.08
The BA-II Plus can be used to solve for i, and then n:
0.08 [1/x] [PV]
40 [N] 1 [+/-] [PMT] [CPT] [I/Y]
Result is 7.5677.
[] 1 [=] [I/Y] [CPT] [N]
Answer is 27.04.
Solution 6.13
C Section 6.03, Annuity-Due
The present value of the annuity-immediate is:
1  1.0810
10  a10  10   67.1008
0.08
The annuity-due equation of value at time 0 can be used to solve for X:
Xa   67.1008
12
1  1.0812
X  67.1008
0.08
1.08
X  8.1390  67.1008
X  8.2444
Alternatively, the BA-II Plus can be used to answer this question:
10 [N] 8 [I/Y] 10 [PMT] [CPT] [PV]
12 [N] [CPT] [PMT]
Answer is 8.2444.
Solution 6.14
C Section 6.03, Annuity-Due
The value of the annuity at the end of 10 years is:
s 10

But the question asks for the value on the date of the last deposit, and the last deposit is
made at time 9. Therefore, the value at the end of 10 years must be discounted by back
by one year:
s10 1.0410  1
 s10   12.0061
1 i 0.04
Solution 6.15
B Section 6.03, Annuity-Due
This question is similar to Question 6.02, but the payments now occur at the beginning of
each year instead of the end of each year.
2, 000a 
 Xa
15 0.08 5 0.08
1  v15 1  v5
2, 000   X
0.08 0.08
1.08 1.08
2, 000(1  1.0815 )  X (1  1.085 )
X  4,287.55
The BA-II Plus can be used to solve the problem. We can leave the calculator in the END
mode, because the denominators in the equation of value cancel, so the answer is the
same regardless of whether the annuities pay at the beginning or end of each year:
15 [N] 8 [I/Y] 2,000 [PMT] [CPT] [PV]
Result is 17,118.96.
5 [N] [CPT] [PMT]
Solution 6.16
D Section 6.03, Annuity-Due
d 0.05
i    0.05263
1  d 1  0.05
The equation of value at time 0 can be used to solve for X:
3 X

0.05263 0.05
X  2.85
Solution 6.17
D Section 6.03, Annuity-Immediate and Annuity-Due
The correct answer is Choice D.
Statement I is true because the present value of the perpetuity-due is equal to X plus the
present value of the perpetuity-immediate:
X X
X  
i i

Statement II is true because the present value of the perpetuity immediate is equal to the
present value of the annuity-immediate plus the present value of payments that would
have continued after the annuity immediate expires. A convenient way to show this
mathematically is to begin with the fact that the complement of the discount factor is less
than one:
1  1  vn
X X
 (1  v n )
i i
X
 Xan
i
Statement III is false, because if the interest rate is high enough and/or annuity’s term is
long enough, then the present value of the annuity-due can be more than the present
value of the perpetuity-immediate. As an example, suppose that the annuity-due
payments end in 100 years and the annual effective interest rate is 50%:
n 100
  X 1  v (1  i )  X 1  1.5
a (1.5)  3 X
n i 0.5
X
PV (Perpetuity-immediate)   2X
i
Solution 6.18
C Section 6.03, Level Annuities
The accumulated value of the annuity-immediate at time (n  1) is equal to the
accumulated value of an annuity-due:
sn  (1  i )  30.7725
sn  30.7725
(1  i )n  1
 30.7725
d
3.7975  1
 30.7725
d
d  0.0909
We can use d to find the value of n:
(1  i )n  3.7975
(1  d )n  3.7975
(1  0.0909)n  3.7975
n  ln(0.9091)  ln(3.7975)
n  14.00
Solution 6.19
D Section 6.03, Level Annuities
The parents make 18 contributions of X. On the son’s 19th birthday, the equation of value
is:
X 1.0418  1.0417    1.04  40, 000 1  v  v 2  v 3 
   
18
X  1.04k  40, 000 1  v  v 2  v 3 
 
k 1

Only Choices A and D show 18 contributions, so the correct answer must be Choice A or
Choice D.
The right side of the equation in both Choices A and D shows the value of the withdrawals
at time 19. The left side of Choice A shows the value of the contributions at time 0, so
the equation of value is not correct. The left side of Choice D shows the value of the
contributions at time 19, so the equation of value is valid, and Choice D is the correct
answer.
Solution 6.20
A Section 6.03, Annuity-Due
The amount needed to fund Justin’s retirement on his 65th birthday is:
4, 000
 1, 000  551,724.1379
7.25
We can solve for the monthly contributions into the fund:
Xs2512 5%/12  551,724.1379
Xs300 0.4167%  551,724.1379
1.004167300  1
X  551,724.1379
0.004167
1.004167
X  597.9910  551,724.1379
X  922.6295
We can use the BA II Plus to answer this question:
4,000 [] 7.25 [] 1,000 [=] [FV]
300 [N] 5 [] 12 [=] [I/Y]
[CPT] [PMT]
Answer is 922.6295.
Solution 6.21
The effective 2-year interest rate is found below:
1/2 2
 i(1/2)   i(2) 
1    1  
 1 / 2   2 
 
1/2 2
 i(1/2)   0.06 
1    1  
 1 / 2   2 

i(1/2)
 0.1255
1/2
Let’s use 2 years as our unit of time:
 1  1.125510
20a10 0.1255
 20   20  6.2185  124.37
0.1255
1.1255

1.03 [yx] 4 [=] [] 1 [] [=] 100 [=] [I/Y]

10 [N] 20 [PMT] [CPT] [PV]

Solution 6.22
E Section 6.03, Annuity-Due
1.0715  1.0714  1.0713  1.0712  1.0711

2 1.0710  1.079  1.078  1.077  1.076 
3 1.07 5
 1.074  1.073  1.072  1.071 

 1.0715  1.0714    1.071 

 1.0710  1.079    1.071 
 1.075
 1.074    1.071 
1, 0715  1 1, 0710  1 1, 075  1
 s15  s10  s5   
0.07 0.07 0.07
1.07 1.07 1.07
 26.8881  14.7836  6.1533  47.8249
15 [N] 7 [I/Y] 1 [PMT] [CPT] [FV] [STO] 1
10 [N] [CPT] [FV] [STO] 2
5 [N] [CPT] [FV] [+] [RCL] 2 [+] [RCL] 1 [=]
Solution 6.23
On June 1, 2060, the amount in Fred’s account is:
5, 000  1.092050 2025  29, 687.69  1.092050 2040
 5, 000  1.0925  29, 687.69  1.0910  113,396.9622
The equation of value as of June 1, 2060 is:
2, 000sn  1.0725  n  113, 396.9622

Let’s discount both sides for 25 years to convert the equation above into an equation of
value for Ethel as of June 1, 2035:
2, 000sn  1.0725  n 113, 396.9622

25
1.07 1.0725
2, 000sn  1.07n  20, 893.2970
  20, 893.2970
2, 000a n
1  1.07n
2, 000   20, 893.2970
0.07
1.07
1.07n  0.3166
n  ln(1.07)  ln(0.3166)
n  17
5,000 [] 1.09 [yx] 25 [=] [+] 29,687.69 [] 1.09 [yx] 10 [=]
[] 1.07 [yx] 25 [=] [PV]
7 [I/Y] 2,000 [+/-] [PMT]
[CPT] [N]
Result is 17.
Solution 6.24
At the end of 15 years, the value in the fund is:
1.1215  1
500s15 0.12  500   1.12  500  41.7533  20, 876.6402
0.12
The effective 6-month interest rate is:
1.120.5  1  0.05830
Let n be the number of 6-month periods that the fund can support withdrawals of 2,000:
2, 000a  20, 876.64
n 0.0583
1  1.0583n
 1.0583  10.4383
0.0583
1  1.0583n  0.5750
n  15.1021
The 15th payment of 2,000 is made at the beginning of the 15th 6-month period, which is
the same as the end of the 14th period, so the 15th payment is made at the end of 7 years.
Six months after the 15th payment of 2,000 is made, the balance in the fund is:
20, 876.6402(1.0583)15  2, 000s15 0.0583
1.058315  1
 48, 842.2629  2, 000   1.0583
0.0583
 48, 842.2629  2, 000  24.3165
 209.33


15 [N] 12 [I/Y] 500 [PMT] [CPT] [FV]
(Result is 20,876.6402)
[PV]
1.12 [yx] 0.5 [=] [] 1 [=] [] 100 [=] [I/Y]
2,000 [PMT] 0 [FV] [CPT] [N]
(Result is 15.1021)
15 [N] [CPT] [FV]
Answer is 209.33.
Solution 6.25
B Section 6.03, Level Annuities
The first tuition payment is due at the beginning of the 18th year, which is at the end of 17
years. The payment of X is made at the end of 18 years. The equation of value at the
end of 17 years is:
700s  X  v  7, 000 1.0417  1.0418 v 
 18   
700s18  Xv  7, 000 1.0417  1.0418 v 
 
1.0818  1 X
700    7, 000  3.8237
0.08 1.08
X
700  37.4502   26, 765.5957
1.08
X
26, 215.1706   26,765.5957
1.08
X  594.46
18 [N] 8 [I/Y] 700 [PMT] [CPT] [FV]
1.04 [y ] 17 [+] 1.04 [yx] 18 [] 1.08 [=] [] 7,000
x
[+] [RCL] [FV] [=] [] 1.08

Answer is 594.46.
Solution 6.26
B Section 6.04, Deferred Annuities
Since Amy receives the first n payments and Beth receives the next m payments, the
difference between the present values of their payments is:
  X  a
  Xv n a
Xa    X  a
  v n a   v n 1  v  (1  i )a 
n m  n m  n m
 X a
 - v n-1a 
 n m
This matches Choice B.

Solution 6.27
D Section 6.04, Deferred Perpetuities
Aaron’s share of the present value of the perpetuity is 30%:
X
Xan  0.3 
i
1  v n  0.3
v n  0.7
Charlie’s share of the present value of the perpetuity is K:
X X
 v 3n  K 
i i
0.73  K
K  0.343
Solution 6.28
C Section 6.04, Deferred Annuities
 
12
i  1 0.07  1  0.07229
12
The first payment from the perpetuity is made in 7 years. At the end of 6 years, the
perpetuity is a perpetuity-immediate. The present value of the perpetuity-immediate is:
500 6 500
PV0  v 6   1.07229    4, 550.06
0.07229 0.07229
Solution 6.29
B Section 6.04, Deferred Annuities
Since the first two sets of cash flows have the same present value at time 0, they must
also have the same present value at time 1:
Time 0: 10, 000v  1, 200a12

Time 1: 10, 000  1, 200a12
We can use the BA II Plus to obtain the annual effective interest rate:
12 [N] 10,000 [PV] 1,200 [PMT] [CPT] [I/Y]
Result is 7.4503
The annual effective interest rate is 7.4503%.
The third set of cash flows consists of 11 payments beginning at time 20. The equation of
value at time 0 for the first and third sets of cash flows is below:
10, 000v  v 20 Xa

11
10, 000  v19 Xa

11
We can use the BA II Plus to find X. Continuing from the calculation of the interest rate
above, and leaving the calculator in the BGN mode, we have:
11 [N] 1 [PMT] [CPT] [PV]
[] ( [RCL] [I/Y] [] 100 [+] 1) [yx] 19 [=] [1/x] [] 10,000 [=]
Result is 4,970.90. Answer is 4,970.90.

Solution 6.30
E Section 6.04, Level Annuity
The present value of the perpetuity-due is equal to the present value of a perpetuity-
immediate plus a payment of 20,000 at time 0:
1 20, 000
20, 000  20, 000a8 0.09  
8 0.11
1.09
1  1.098
 20, 000  20, 000   91,248.4145
0.09
 20, 000  20, 000  5.5348  91,248.4145
 221, 944.7968
 X 
221, 944.7968  Xa 8 0.09
 a 22 0.11
1.098
 1  1.098 1 1  1.1122 
221, 944.7968  X   
0.09

 1.09
1.098 0.11
1.11


221, 944.7968  X 6.0330  4.5545
X  20, 963.06
8 [N] 9 [I/Y] 1 [PMT] [CPT] [PV]
(Result is 6.0330) [+/-] [STO] 1
22 [N] 11 [I/Y] 1 [PMT] [CPT] [PV] [] 1.09 [yx] 8 [=]
(Result is 4.5545) [+/-] [STO] 2
9 [N] 9 [I/Y] 20,000 [PMT] [CPT] [PV] [+/-]
[+] 20,000 [] 0.11 [] 1.09 [yx] 8 [=]
(Result is 221,944.7968) [] [(] [RCL] 1 [+] [RCL] 2 [)] [=]
Answer is 20,963.06.

Chapter 7: Level Annuities, Payable
More than Once per Time Unit
Solution 7.01
The annual interest rate compounded quarterly is:
 
i(4)  1.080.25  1  4  0.07771
The annual rate of payment is 200 per year, and the present value is:
1  v10 1  1.0810
200  a(4)  200   200   200  6.9082  1, 381.63
10 i(4) 0.07771
Alternatively, we can use the quarterly effective interest rate along with the quarterly rate
of payment. The quarterly effective interest rate is:
i(4)
 1.080.25  1  0.01943
4
The quarterly rate of payment is 50 per quarter, and the present value is:
1  1.0194340 1  1.0810
50  a40 0.01943  50   50   50  27.6326
0.01943 0.01943
 1, 381.63
1.08 [yx] 0.25 [] 1 [=] [] 100 [=] [I/Y]
40 [N] 50 [PMT] [CPT] [PV]
Solution 7.02
D Section 7.01, Perpetuity-Immediate
Let’s use one quarter (i.e., 3 months) as our unit of time. If the first payment were at the
end of one unit of time, then the present value would be:
45
 1,500
0.03
Accumulating this amount by one month, we have:
1,500  1.031/3  1, 514.85
Alternatively, we can find the present value as follows:
45 45 45  45 45 45 
     1.031/3     
2/3 5/3 8/3 1.03 2 3
1.03 1.03 1.03  1.03 1.03 
 45 
 1.031/3    1, 514.85
 0.03 

Chapter 7: Level Annuities, Payable More than Once per Time Unit Solutions to End of Chapter Questions
Solution 7.03
48 [N] 15,000 [+/-] [PV] 600 [PMT] [CPT] [I/Y]
(Result is 3.0577)
[] 100 [+] 1 [=] [yx] 3 [1/x] [=] [] 1 [=] [] 12 [=]
Answer is 0.1211.
Solution 7.04
The monthly effective interest rate used to find the present value of Rebecca’s annuity is:
i(12)
 1.081/12  1  0.006434
12
Let X be the monthly annuity payment received by Rebecca. We equate the present
values of David’s and Rebecca’s annuities and solve for X:
1, 000  a10 0.08  X  a120 0.006434
1  1.0810 1  1.0810
1, 000   X
0.08 0.006434
1, 000  6.7101  X  83.4324
6, 710.0814  X  83.4324
X  80.4254
An annual effective rate of 10% is equivalent to the following monthly effective interest
rate:
i(12)
 1.101/12  1  0.007974
12
Rebecca’s payments are accumulated at an annual effective interest rate of 10%:
1.1010  1
80.4254  s120 0.007974  80.4254   80.4254  199.8639
0.007974
 16, 074.1259
David’s payments are accumulated at an annual effective interest rate of 9%:
1.0910  1
1, 000  s10 0.09  1, 000   1, 000  15.1929  15,192.9297
0.09
The difference between the accumulated value of Rebecca’s payments and the
accumulated value of David’s payments is:
16, 074.1259  15,192.9297  881.20
10 [N] 8 [I/Y] 1,000 [PMT] [CPT] [PV]
1.08 [yx] 12 [1/x] [] 1 [=] [] 100 [=] [I/Y]
120 [N] [CPT] [PMT]
Result is 80.4254.
1.10 [yx] 12 [1/x] [] 1 [=] [] 100 [=] [I/Y]
0 [PV] [CPT] [FV] [+/-] [STO] 1
10 [N] 9 [I/Y] 1,000 [PMT] [CPT] [FV]
[+] [RCL] 1 [=]

Answer is 881.20.
Solution 7.05
The monthly effective interest rate for the first 22 months is:
0.09
 0.0075
12
The accumulated value of the loan after 22 months minus the accumulated value of the
payments is:
1.007522  1
30, 000(1.0075)22  700s22 0.0075  35,360.02  700 
0.0075
 35, 360.02  700  23.8223  18, 684.4093
The new monthly effective interest rate used to refinance the loan is:
0.06
 0.005
12
The equation of value for the refinanced loan after 22 months is:
18, 684.4093  Xa30 0.005
1  1.00530
18, 684.4093  X 
0.005
18, 684.4093  27.7941X
X  672.24
22 [N] 9 [] 12 [=] [I/Y] 30,000 [PV] 700 [+/-] [PMT] [CPT] [FV]
(Result is 18,684.4093)
[PV] 30 [N] 6 [] 12 [=] [I/Y] 0 [FV] [CPT] [PMT]
Answer is 672.24.
Solution 7.06
E Section 7.01, Annuity-Immediate
The monthly interest rate for the first 60 months is:
0.072
 0.006
12
The accumulated value of the loan after 60 months minus the accumulated value of the
payments is:
1.00660  1
294,584.81(1.006)60  2, 000s60 0.006  421, 783.1173  2, 000 
0.006
 421, 783.1173  2, 000  71.9647  277, 853.6466
The new interest rate to refinance the loan is:
0.036
 0.003
12

The equation of value for the refinanced loan after 60 months is:
277, 853.6466  2, 000an 0.003
1  1.003n
277, 853.6466  2, 000 
0.003
0.5832  1.003n
ln(0.5832)  n  ln(1.003)
n  180
60 [N] 7.2 [] 12 [=] [I/Y] 294,584.81 [PV] 2,000 [+/-] [PMT]
[CPT] [FV]
(Result is 277,853.6466)
[PV] 3.6 [] 12 [=] [I/Y] 2,000 [PMT] 0 [FV] [CPT] [N]
Answer is 180.
Solution 7.07
B Section 7.01, Perpetuity-Immediate
The present value of the first annuity can be used to find the effective 4-year interest
rate:
15
 37.50
i(1/4)
1/4
i(1/4)  0.40
1/4
The 4-month effective interest rate is found below:

m p
 i(m)   i( p) 
1    1  
 m   p 
 
3
1/4  i(3) 
1.40  1 
 3 


i(3)
 
1/3
 1.401/4  1  0.02844
3
The present value of the second perpetuity is:
1
 35.17
0.02844
Solution 7.08
B Section 7.01, Level Annuity
0.054
 0.0045
12

August 1 of the year (y + 5), is 67 months after January 1 of the year y. During these 67
months, there are 22 quarterly payments of 1,000. The equation of value at time 0 is:
 1, 000 1, 000 1, 000  1.7 X
X   
3 6 66 
1.0045 1.0045 1.0045  1.004567
22
1, 000 1.7 X
X  1.00453k 
1.004567
k 1
The answer is Choice B.
Solution 7.09
E Section 7.01, Level Annuity
0.054
 0.0045
12
The quarterly effective interest rate is:
1.00453  1  0.01356
August 1 of the year (y + 5) is 67 months after January 1 of the year y. During these 67
months, there are 22 quarterly payments of 1,000.
The equation of value at time 0 is:
 1, 000 1, 000 1, 000  1.7 X
X   
3 6 66 
1.0045 1.0045 1.0045  1.004567
22
1, 000 1.7 X
X  1.00453k 
1.004567
k 1
1.7 X
X  1, 000  a22 0.01356 
1.004567
1  1.0135622  1.7 
1, 000    1 X
0.01356 67
 1.0045 
18, 911.8629  0.2584 X
X  73, 201.33
Solution 7.10
The annual discount rate compounded quarterly is found below:
4
 d(4) 
1    1.08
 4 

d(4)  0.07623
The annual rate of payment is 200 per year, and the present value is:
10
(4)  200  1  v 1  1.0810
200  a  200   200  7.0424  1, 408.47
10 d(4) 0.07623
Alternatively, we can use the quarterly effective interest rate along with the quarterly rate
of payment. The quarterly effective interest rate is:
i(4)
 1.080.25  1  0.01943
4

The quarterly rate of payment is 50 per quarter, and the present value is:
40 10
 1  1.01943 1  1.08
50  a 40 0.01943
 50   1.01943  50   1.01943
0.01943 0.01943
 50  28.1694  1, 408.47
1.08 [yx] 0.25 [] 1 [=] [] 100 [=] [I/Y]
40 [N] 50 [PMT] [CPT] [PV]
Solution 7.11
C Section 7.02, Perpetuity-Due
Let’s use one quarter (i.e., 3 months) as our unit of time. The present value of the
perpetuity-immediate is:
45
 1,500
0.03
1.031/3  1  0.009902
We now use one month as our unit of time and set the present value of the perpetuity-
immediate equal to the present value of the perpetuity-due:
 1 
1,500  X   1
 0.009902 
X  14.71
Alternatively, we can use the monthly effective discount rate:
X
1,500 
d(4)
4
X
1,500 
0.009902
1.009902
X  14.71
Solution 7.12
Let P be the purchase price and j be the monthly effective interest rate. The equation of
value at time 0 is:
P 
P  a
11 12 j
1 
1  a12 j
11

We can use the BA-II Plus calculator to solve for the monthly effective interest rate. Once
we have the monthly effective interest rate, we convert it into the annual effective interest
rate:
[2nd] [[BGN] [2nd] [SET] [2nd] [QUIT]
12 [N] 1 [PV] 11 [1/x] [+/-] [PMT] [CPT] [I/Y]
(Result is 1.6231)
[] 100 [+] 1 [=] [yx] 12 [=] [] 1 [=]
Answer is 0.2131.
Solution 7.13
D Section 7.02, Level Annuities
The equation of value at the end of 11 years is:
100s (1  i )6  200s36 j (1  i )3  300s36 j  (1  i )2  30, 000
 36 j 
The equation can be rearranged to match Choice D:
 s (1  i )6  2s36 j (1  i )3  3s36 j  (1  i )2  300
 36 j 
s36 j (1  i )2 (1  i )6  2(1  i )3  3  300
 
Solution 7.14
The monthly effective interest rate used to find the present value of Minnie’s annuity-
immediate is:
i(12)
 1.081/12  1  0.006434
12
Let X be the monthly annuity payment received by Minnie. We equate the present values
of Harry and Minnie and solve for X:

1, 000  a  X a
10 0.08 120 0.006434
10
1  1.08 1  1.0810
1, 000   1.08  X   1.006434
0.08 0.006434
1, 000  7.2469  X 
7,246.8879  X  83.9692
X  86.3041
An annual effective rate of 10% is equivalent to the following monthly effective interest
rate:
i(12)
 1.101/12  1  0.007974
12
Minnie’s payments are accumulated at an annual effective interest rate of 10%:
1.1010  1
86.3041  s120 0.007974  86.3041   1.007974
0.007974
 86.3041  201.4576
 17, 386.6215

Harry’s payments are accumulated at an annual effective interest rate of 9%:

10
1.09  1
1, 000  s10 0.09  1, 000   1.09  1, 000  16.5603  16,560.2934
0.09
The difference between the accumulated value of Minnie’s payments and the accumulated
value of Harry’s payments is:
17, 386.6215  16,560.2934  826.33
10 [N] 8 [I/Y] 1,000 [PMT] [CPT] [PV]
1.08 [yx] 12 [1/x] [] 1 [=] [] 100 [=] [I/Y]
120 [N] [CPT] [PMT]
Result is 86.3041.
1.10 [yx] 12 [1/x] [] 1 [=] [] 100 [=] [I/Y]
0 [PV] [CPT] [FV] [+/-] [STO] 1
10 [N] 9 [I/Y] 1,000 [PMT] [CPT] [FV]
[+] [RCL] 1 [=]
Answer is 826.33.
Solution 7.15
A Section 7.02, Annuity-Due
0.07
 0.005833
12
To have 2,000 of monthly income beginning on her 70th birthday, the woman needs the
following lump sum on her 70th birthday:
2, 000
 1, 000  211, 640.2116
9.45
Her contributions must accumulate to 211,640.2116:
Xs3312 0.005833  211, 640.2116
1.005833396  1
X  1.005833  211, 640.2116
0.005833
1,553.0706 X  211, 640.2116
X  136.27
2,000 [] 9.45 [] 1,000 [=] [FV]
33 [] 12 [=] [N] 7 [] 12 [=] [I/Y]
[CPT] [PMT]
Solution 7.16
Let j be the effective interest rate for an interval of 5 years:
j  (1  i )5  1

There are 8 5-year intervals in 40 years, and there are 4 5-year intervals in 20 years.
Therefore, the accumulated value at the end of 8 intervals is equal to 4 times the
accumulated value at the end of 4 intervals:
250s  4  250s
8j 4j
8
(1  j )  1 (1  j )4  1
 4
j / ( j  1) j / ( j  1)
(1  j )8  1
4
(1  j )4  1
(1  j)4  1  4
(1  j)4  3
j  0.3161
The accumulated amount at the end of 40 years is:
1.31618  1
X  250s8 0.3161  250   1.3161  8, 327.63
0.3161
The BA-II Plus can be used as follows:
3 [yx] 0.25 [=] [] 1 [=] [] 100 [=] [I/Y]
8 [N] 250 [PMT] [CPT] [FV]
Result is 8,327.63. Solution is 8,327.63.
Solution 7.17
B Section 7.02, Perpetuities
We can use the price of the first perpetuity to find the value of i:
1
6.74  1
(1  i )3  1
i  0.0550
The annual effective interest rate used to value the second annuity is:
i  0.01  0.0550  0.01  0.0650
The second perpetuity begins at the end of 1 year, so it can be valued as a perpetuity
immediate accumulated for 3 years:
X
6.74   1.06503
4
1.0650  1
X  1.5982
Solution 7.18
C Section 7.02, Level Annuity
The accumulated value at the end of 6 years is:
 
X 1.056  1.054  1.052  3.6581X

3.6581X  X   1.074  X  1.072  7.2507 X

Let j be the 2-year effective rate. The equation of value to be solved is:
Xs5 j  7.2507 X
s5 j  7.2507
We use the BA II Plus to obtain the annual effective yield:

5 [N] 1 [PMT] 7.2507 [FV] [CPT] [I/Y]
(Result is 12.6560)
[] 100 [+] 1 [=] [yx] 0.5 [=] 1 [=]
Answer is 0.0614.
Solution 7.19
1.071/12  1  0.005654
The withdrawals of $35,000 are made at times 17, 18, 19, and 20.
 35, 000 
Xa 2012 0.005654
 a4 0.07
1.0717
1  1.005654240 1  1.074
X  1.05654  11, 080.1037   1.07
0.05654 0.07
X  131.8986  11, 080.1037  3.6243
X  304.46
1.07 [yx] 12 [1/x] [=] [] 1 [=] [] 100 [=] [I/Y]
20 [] 12 [=] [N] 1 [PMT] [CPT] [PV]
(Result is 131.8986) [STO] 1
4 [N] 7 [I/Y] 35,000 [PMT] [CPT] [PV]
(Result is 126,851.0616) [] 1.07 [yx] 17 [=]
[] [RCL] 1 [=]
Answer is 304.46.
Solution 7.20
D Section 7.03, Level Annuities, Payable Continuously
The present value of the perpetuity is:
 1  vn  10 50
Lim 50  an   Lim 50    50    714.29
n  n  
 r  r 0.07

Solution 7.21
E Section 7.03, Level Annuities, Payable Continuously
The accumulated value of the annuity is:
(1  i )n  1 e100.07  1
50  sn  50   50   50  14.4822  724.11
r 0.07
Solution 7.22
D Section 7.03, Level Annuities, Payable Continuously
The present value of the continuously payable annuity is:
a10  8.1277
1  e 10
 8.1277

The derivative is:
da10
 37.735
d
d  1  e10 
   37.735
d   

10e10   (1  e 10 )
 37.735
2
We can use the present value of the annuity to find an expression for e10 :
1  e 10
 8.1277

e10  1  8.1277
We can now solve for  :
10e 10   (1  e 10 )
 37.735
2
10(1  8.1277 )  (1  e 10 )
 37.735
2
10(1  8.1277 ) (1  e 10 )
  37.735
2 2
(1  e10 )
10(1  8.1277 )   37.735

10(1  8.1277 )  8.1277  37.735
1.8723  43.542
  0.04300

Solution 7.23
A Section 7.03, Level Annuities
We can find the present value of an (n+1)–year annuity-immediate:

a  an 1  1
n 2
13.0685  an 1  1
an 1  12.0685
We can find the accumulated value of an (n+1)–year annuity-immediate:

sn  sn 1  1
17.3958  sn 1  1
sn 1  18.3958
We can now solve for the (n+1)–year discount factor:

an 1  v n 1  sn 1
12.0685  v n 1  18.3958
v n 1  0.6560
We can use the present value of the (n+1)–year annuity-immediate to solve for i:
an 1  12.0685
1  v n 1
 12.0685
i
1  0.6560
 12.0685
i
i  0.02850
The present value of the 1-year annuity paid continuously is:
1 1
1v 1.02850  0.9861
a1  
r ln(1.02850)

Chapter 8: Arithmetic Progression
Annuities
Solution 8.01
D Section 8.01, Increasing Annuity
The annuity can be broken down into a level annuity-immediate and an increasing
annuity-immediate:
1  v 21 a  21v 21
PV0  45a21  5(Ia)21  45   5  21
0.05 0.05
13.4622  7.5378
 45  12.8212  5   576.9519  5  118.4884
0.05
 1,169.39
Alternatively, we can use the PIn method with the following parameters:
P1  50 I 5 n  21
 I In n  5  1  (1.05)21 5  21
PV0   P1   an  v   50    (1.05)21
 i i  0.05  0.05 0.05
 150  12.8212  753.7790  1,169.39
21 [N] 5 [I/Y] 50 [+] 5 [] 0.05 [=] [PMT]
5 [] 21 [] 0.05 [=] [+/-] [FV] [CPT] [PV]
Solution 8.02
C Section 8.01, Increasing Annuity
If the payments occurred at the end of each year, then the present value would be:
45a21  5(Ia)21
Since each of the payments occur 6 months earlier than the end of each year, the present
value factors implied in the expression above discount the cash flows by 6 months too
much. To fix this we multiply by a 6-month accumulation factor. The present value is:
 45a21  5(Ia)21   1.050.5
The portion in parentheses above can be found using the PIn method:
P1  50 I 5 n  21
The portion in parentheses is:
 I In n  5  1  (1.05)21 5  21
P
 1  a
 n  v   50    (1.05)21
 i  i  0.05  0.05 0.05
 150  12.8212  753.7790  1,169.3939
PV0  1,169.3939  1.050.5  1,198.27

Chapter 8: Arithmetic Progression Annuities Solutions to End of Chapter Questions

21 [N] 5 [I/Y] 50 [+] 5 [] 0.05 [=] [PMT]
5 [] 21 [] 0.05 [=] [+/-] [FV] [CPT] [PV]
Result is 1,169.3939.
[] 1.05 [yx] 0.5 [=]
Solution 8.03
The annuity can be broken down into a level annuity-immediate and an increasing
annuity-immediate:
1.0521  1 s  21
AV21  45s21  5(Is)21  45   5  21
0.05 0.05
37.5052  21
 45  35.7193  5   1, 607.3663  5  330.1043
0.05
 3, 257.89
Alternatively, we can use the PIn method with the following parameters:
P1  50 I 5 n  21
 I In n  5  1  (1.05)21 5  21
PV0   P1   an  v   50    (1.05)21
 i i  0.05  0.05 0.05
 150  12.8212  753.7790  1,169.39
AV21  1,169.39  1.0521  3, 257.89
21 [N] 5 [I/Y] 50 [+] 5 [] 0.05 [=] [PMT]
5 [] 21 [] 0.05 [=] [+/-] [FV] [CPT] [PV]
Result is 1,169.39.
[] 1.05 [yx] 21 [=]
Solution 8.04
E Section 8.01, Increasing Annuities
The increasing annuity is payable monthly, and the annual rate of payment in the first
year is 60:
s  10
60  (Is)(12)  60  10
10 i(12)
The annual effective interest and discount rates are:
12
 0.06  0.06128
i  1    1  0.06168 d   0.05809
 12  1.06128

The accumulated value of the annuity-immediate is:

(1.06168)10 1
s10  10 10
60   60  0.05809
 60  14.1045 10  60  68.4085
0.06 0.06
i(12)
 4,104.51
The BA-II Plus can be used to answer this question as follows:
1.005 [yx] 12 [] 1 [=] [] 100 [=] [I/Y]
10 [N] 1 [PMT] [CPT] [FV]
Result is 14.1045.
[+/-] [] 10 [=] [] 0.06 [] 60 [=]
Answer is 4,104.51.
Alternatively, we can use the PIn method to obtain the present value of an increasing
annuity-immediate payable annually:
  10v10
a
60  (Ia)10  60  10
i
Then, we can multiply by the ratio i / i(12) to obtain the present value of the increasing
annuity-immediate payable monthly:
i   10v10
a   10v10
a
 60  10  60  10 )
 60  (Ia 10
i(m) i i(m)
Finally, we can accumulate the annuity for 10 years to obtain the accumulated value.
Using the PIn method, we have:
P1  60 I  60 n  10 i  1.00512  1  0.06168
We use the BA II Plus in the END mode
( 0.06 [] 12 + 1) [yx] 12 [] 1 [=] [STO] 1
10 [N] [RCL] 1 [] 100 [=] [I/Y] 60 [+] 60 [] [RCL] 1 [=] [PMT]
60 [] 10 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV]
Result is PV = 2,194.6043. (We have 60  (Ia)10  2,194.6043 )
[] [RCL] 1 [] 0.06 [=]

Result is 2,255.9732. )
(We have 60  (Ia  2,255.9732 )
10
[×] ( 1 [+] [RCL] 1 ) [yx] 10 [=]
Solution 8.05
D Section 8.01, Increasing Annuities
The increasing annuity is payable monthly, and the annual rate of payment in the first
year is 24:
  20v 20
a
)(12)  24 
24  (Ia 20
20 d(12)

The annual effective interest and discount rates are:

12
 0.12  0.1268
i  1    1  0.1268 d   0.1125
 12  1.1268
The nominal discount rate compounded monthly is:
0.01
d(12)   12  0.1188
1.01
The present value of the annuity-due is:
1 1.126820  20
  20v 20
a 0.1126
20 1.126820 8.0692 1.8361
24   24   24 
0.1188 0.1188
d(12)
 24  52.4617  1, 259.08
1.01 [yx] 12 [] 1 [=] [] 100 [=] [I/Y]
20 [N] 1 [+/-] [PMT] 20 [FV] [CPT] [PV]
Result is 6.2331.
[] 0.01 [] 1.01 [] 12 [=]
Result is 52.4617
[] 24 [=]
Answer is 1,259.08.
Solution 8.06
A Section 8.01, Increasing Annuity & Reinvested Funds
There are two funds, one earning 6% and one earning 3%. The amount of each level
deposit is denoted by X. The deposits into the funds are described below:
Time 6% 3%
0 X
1 X X  0.06
2 X 2 X  0.06
3 X 3 X  0.06
14 X 4 X  0.06
15 5 X  0.06

Since the interest from the 6% fund is paid into the 3% fund, the value of the 6% fund at
the end of 5 years is 5X. The accumulated value of the 3% fund can be found using an
increasing annuity immediate:
5 X  (Is)5 0.03  0.06 X  800
s5 0.03  15
5X   0.06 X  800
0.03
1.035  1
5
0.03 / 1.03
5X   0.06 X  800
0.03
5.4684  5
5X   0.06 X  800
0.03
5 X  15.6137  0.06 X  800
X  134.75
We can use the BA II Plus to obtain the value of (Is)5 0.03 :
5 [N] 3 [I/Y] 1 [PMT] [CPT] [FV] [] 1.03 [+/-]

[] 5 [=] [] 0.03 [=]
Result is 15.6137.
Solution 8.07
C Section 8.01, Increasing Annuity & Reinvested Funds
There are two funds, one earning 7% and one earning 4%. The amount of each level
deposit is denoted by X. The deposits into the funds are described below:
Time 7% 4%
0 X
1 X X  0.07
2 X 2 X  0.07
  
14 X 14 X  0.07
15 15 X  0.07
Since the interest from the 7% fund is paid into the 4% fund, the value of the 7% fund at
the end of 15 years is 15X. The accumulated value of the 4% fund can be found using an
increasing annuity immediate:
15 X  (Is)15 0.04  0.07 X  25, 000
s15 0.04  15
15 X   0.07 X  25, 000
0.04
1.0415  1
 15
0.04 / 1.04
15 X   0.07 X  25, 000
0.04
20.8245  15
15 X   0.07 X  25, 000
0.04
15 X  145.6133  0.07 X  25, 000
X  992.34
We can use the BA II Plus to obtain the value of (Is)15 0.04 :
15 [N] 4 [I/Y] 1 [PMT] [CPT] [FV] [] 1.04 [+/-]

[] 15 [=] [] 0.04 [=]

Result is 145.6133.
Solution 8.08
B Section 8.01, Increasing Coupons
The 6-month effective interest rate is:
0.08
 0.04
2
Since the last coupon payment was 30, then next coupon payment is X  30 . The
present value of the bond is 1,300. The time 0 equation of value can be used to solve for
X:
30  X 30  2 X 30  18 X 1, 000
    1, 300
2 18
1.04 1.04 1.04 1.0318
1, 000
30  a18 0.04  X (Ia)18 0.04   1, 300
1.0418
1  1.0418 a  18(1.04)18
30   X  18  493.6281  1, 300
0.04 0.04
13.1657  18(1.04)18
30  12.6593  X   493.6281  1,300
0.04
379.7789  X  107.0091  493.6281  1, 300
X  3.99
18 [N] 4 [I/Y] 1 [PMT] [CPT] [PV]
[] 1.04 [=] [+/-] [] 18 [] 1.04 [yx] 18 [=] [] 0.04 [=] [STO] 1
30 [PMT] 1,000 [FV] [CPT] [PV] + 1,300 [=]
[] [RCL] 1 [=]
Answer is 3.99.
Solution 8.09
C Section 8.02, Increasing Annuity
P1  200 I 4 n  75
 I In n  4  1  (1.08)75 4  75
PV0   P1   an  v   200    (1.08)75
 i i  0.08  0.08 0.08
 250  12.4611  11.6748
 3,103.60
Using the BA II Plus, we have:
75 [N] 8 [I/Y] 200 [+] 4 [] 0.08 [=] [PMT]
4 [] 75 [] 0.08 [=] [+/-] [FV]
[CPT] [PV]

Solution 8.10
B Section 8.02, Varying Annuities
The time-0 equation of value shows that the amount of the loan is equal to the present
value of the payments that repay the loan:
15, 000  100(Ia)10  Xv10 a15
Let’s use the PIn method to find the present value of the increasing annuity:
P1  100 I  100 n  10
 I In n
100(Ia)10   P1   an  v
 i  i
 100  1  (1.03)10 100  10
 100    (1.03)10
 0.03  0.03 0.03
 3, 433.3333  8.5302  24, 803.1305  4, 483.8992
We can now use the equation of value to solve for X:
15, 000  100(Ia)10  Xv10 a15
15, 000  4, 483.8992  Xv10 a15
1  1.0315
15, 000  4, 483.8992  X  1.0310 
0.03
15, 000  4, 483.8992  X  1.0310  11.9379
10,516.1008  8.8829 X
X  1,183.85
10 [N] 3 [I/Y]
100 [+] 100 [] 0.03 [=] [PMT]
100 [] 10 [] 0.03 [=] [+/-] [FV]
[CPT] [PV]
(Result is 4,483.8992.)
[+] 15,000 [=] [] 1.03 [yx] 10 [=] [PV]
15 [N] 0 [FV] [CPT] [PMT]
Solution 8.11
We use one month as the unit of time. The monthly effective interest rate is:
1/3
 0.07 
1    1  0.005800
 4 
P1  3 I 3 n  72 i  0.005800


 I In n
PV0   P1   an  v
 i  i
 3  1  (1.005800)72 3  72
 3    (1.005800)72
 0.005800  0.005800 0.005800
 520.2741  58.7213  24,559.9366  5, 991.24
0.07 [] 4 [] 1 [=] [yx] 3 [1/x] [=] [] 1 [=] [STO] 1
72 [N] [RCL] 1 [] 100 [=] [I/Y] 3 [+] 3 [] [RCL] 1 [=] [PMT]
3 [] 72 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV]
Result is PV = 5,991.24. Answer is 5,991.24.
Solution 8.12
C Section 8.02, Increasing Annuities
The value of Joel’s perpetuity-due can be used to find the interest rate:
150
3,150  150 
i
i  0.05
Using the PIn method, we have the following values for Ellen’s annuity:
P1  P I  20 n  15
The formula for the present value can be used to find the value of the first payment:
 I In n
PV0   P1   an  v
 i i
 20  1  (1.05)15 20  15
3,150   P    (1.05)15
 0.05  0.05 0.05
3,150   P  400   10.3797  2, 886.1026
P  181.53
15 [N] 5 [I/Y] 3,150 [+/-] [PV] 20 [] 15 [] 0.05 [=] [+/-] [FV]
[CPT] [PMT]
(Result is 581.5319)
[] 20 [] 0.05 [=]
Answer is 181.53.
Solution 8.13
E Section 8.02, Increasing Annuity
Let’s use the PIn method find the value of the annuity at the end of 4 years. We have:
P1  500 I  250 n  20
 I In n  250  1  (1.06)20 250  20
PV4   P1   an  v   500    (1.06)20
 i  i  0.06  0.06 0.06
 4, 666.6667  11.4699  25, 983.7272  27,542.5718

To find the present value at time zero, we discount for 4 years:

27,542.5718
 21, 816.30
1.064
20 [N] 6 [I/Y] 500 [+] 250 [] 0.06 [=] [PMT]
250 [] 20 [] 0.06 [=] [+/-] [FV]
[CPT] [PV]
[] 1.06 [yx] 4
Solution 8.14
B Section 8.02, Increasing Annuities
1/3
 0.07 
1    1  0.005800
 4 
P1  5 I 5 n  72 i  0.005800
 I In n
PV0   P1   an  v
 i i
 5  1  (1.005800)72 5  72
 5    (1.005800)72
 0.005800  0.005800 0.005800
 867.1234  58.7213  40, 933.2277  9, 985.40
0.07 [] 4 [] 1 [=] [yx] 3 [1/x] [=] [] 1 [=] [STO] 1
72 [N] [RCL] 1 [] 100 [=] [I/Y] 5 [+] 5 [] [RCL] 1 [=] [PMT]
5 [] 72 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV]
Alternatively, we can use the formula for an increasing annuity-immediate with one month
as the unit of time:
a  72v 72 a  72v 72
5  (Ia)72 0.005800  5  72  5  72
i 0.005800
59.0619  47.4795
 5  5  1, 997.0803  9, 985.40
0.005800

Solution 8.15
E Section 8.02, Continuous Increasing Annuity
The present value of the annuity is:
1  vn
  nv n
a  nv n
50  (Ia)n  50  n
 50  d
r r
1  e 100.07
 10e 100.07
0.07 7.4463  4.9659
 50  1e  50 
0.07 0.07
 50  35.4347  1, 771.74
0.07 [2nd] [ex] [] 1 [=] [] 100 [=] [I/Y]
10 [N] 1 [+/-] [PMT] 10 [FV] [CPT] [PV]
Result is 2.4804.
[] 0.07 [=]
Result is 35.4347
[] 50 [=]
Answer is 1,771.74.
Alternatively, we can use the PIn method to obtain the present value of an increasing
annuity-immediate:
  10v10
a10
50  (Ia)10  50 
i
Then, we can multiply by the ratio i/r to obtain the present value of the continuously
payable annuity:
i a  10v10 a  10v10

 50  10  50  10  50  (Ia)10
r i r
P1  50 I  50 n  10 i  e0.07  1  0.0725
0.07 [2nd] [ex] [] 1 [=] [STO] 1
10 [N] [RCL] 1 [] 100 [=] [I/Y] 50 [+] 50 [] [RCL] 1 [=] [PMT]
50 [] 10 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV]
Result is PV = 1,710.4478.
[] [RCL] 1 [] 0.07 [=]
Solution 8.16
C Section 8.02, Increasing Annuities
We use one month as the unit of time. The quarterly effective interest rate is:
1  0.080.25  1  0.02106


P1  100 I  25 n  28 i  0.02041
 I In n
PV0   P1   an  v
 i i
 25  1  (1.02106)28 25  28
 100    (1.02106)28
 0.02106  0.02106 0.02106
 1,286.8487  20.9908  18,538.2258  8, 473.7144
The future value at the end of 7 years is:
8, 473.7144
AV7   15,190.04
0.927
1 [] 0.08 [=] [1/x] [yx] 0.25 [=] [] 1 [=] [STO] 1
28 [N] [RCL] 1 [] 100 [=] [I/Y] 100 [+] 25 [] [RCL] 1 [=] [PMT]
25 [] 28 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV]
Result is PV = 8,4737144.
0 [PMT] [CPT] [FV]
Answer is 15,190.04.
Alternatively, we can use one quarter as the unit of time in conjunction with a level
annuity and an increasing annuity:
1.0210628  1 s  28
AV7  75  s28 0.02106  25(Is)28 0.02106  75   25  28
0.02106 0.02106
38.4208  28
 75  37.6282  25   2, 822.1154  25  494.7171
0.02106
 15,190.04
Solution 8.17
E Section 8.02, Increasing Annuities
Let’s define the time unit to be 6 months. The 6-month effective interest rate and
discount rate are:
6
 0.06  0.03038
i  1    1  0.03038 d   0.02948
 12  1.03038
The increasing annuity is payable monthly, and there are 6 months in a 6-month time
unit, so the rate of payment during the first 6 months is 60 per 6-month time unit:

a  10v10
60  (Ia)(6)  60  10 0.03038
10 0.03038 i(6)
1  1.00560 60
 10(1.005)
 60  0.02948
0.005  6
60
8.7724  10(1.005)
 60 
0.03
 60  45.2899  2, 717.40


0.06 [] 12 [+] 1 [=] [yx] 6 [] 1 [=] [] 100 [=] [I/Y]
10 [N] 1 [+/-] [PMT] 10 [FV] [CPT] [PV]
Result is 1.3587.
[] 0.005 [] 6 [=]
Result is 45.2899
[] 60 [=]
Answer is 2,717.40.
Alternatively, we can use the PIn method with the time unit set to six months:
P1  60 I  60 n  10 i  0.03038
If the payments were made at the end of each six-month interval, then the present value
would be:
 I In n
 P1   an  v
 i i
 60  1  (1.03038)10 60  10
  60    (1.03038)10
 0.03038  0.03038 0.03038
 2, 035.1455  8.5138  14, 643.1793  2, 683.6264
Since the payments are made monthly, we multiply by an adjustment factor that
accumulates each of the payments to the end of each 6-month interval.
The unit of time continues to be six months:
1.0056  1 0.03038
PV0  s(6)  2, 683.6264   2, 683.6264   2, 683.6264
1 0.005  6 0.03
 2, 717.40
1 [+] 0.06 [] 12 [=] [yx] 6 [] 1 [=] [] [STO] 1
10 [N] [RCL] 1 [] 100 [=] [I/Y] 60 [+] 60 [] [RCL] 1 [=] [PMT]
60 [] 10 [] [RCL] 1 [=] [+/-] [FV]
[CPT] [PV] Result is 2,683.6264.
[] [RCL] 1 [] 0.03 [=]
Solution 8.18
A Section 8.03, Increasing Perpetuity
The value of the level perpetuity-due can be used to find d:
1
26 
d
d  0.03846
The value of the increasing perpetuity-due can be used to find X:
X
4, 732 
d2
X
4, 732 
0.038462
X 7

The 8th payment is:

8 X  8  7  56
Solution 8.19
D Section 8.03, Increasing Perpetuity
We can use the formula for the present value of an increasing perpetuity-immediate to
solve for i:
P1 I
PV0  
i i2
300 25
21,315  
i i2
21,315i 2  300i  25
21,315i 2  300i  25  0
The quadratic formula gives us two solutions for i, and we use the positive one:
300  3002  4  21,315  25

i 
2  21, 315
i  0.0420
Solution 8.20
E Section 8.03, Increasing Perpetuity
We can use the formula for the present value of an increasing perpetuity-due to solve for
i:
P1 I
PV0  P0  
i i2
300 25
21,590  275  
i i2
300 25
21,315  
i i2
21,315i 2  300i  25
21,315i 2  300i  25  0
The quadratic formula gives us two solutions for i, and we use the positive one:
300  3002  4  21,315  25

i 
2  21, 315
i  0.0420

Solution 8.21
B Chapter 8.03, Perpetuities
The equation of value at the end of 1 year can be used to solve for an :
n n
144.09  1.075  (Ia)n  v
i
  nv n  nv n
144.09  1.075  0.075  a n

a n
144.09  0.075 
1.075
an  10.8068
We can now solve for n:

an  10.8068
1  1.075n
 10.8068
0.075
1.075n  0.1895
n  ln(1.075)  ln(0.1895)
n  23.00
Alternatively, the BA-II Plus can be used to solve for n:
144.09 [] 0.075 [=] [+/-] [PV]
7.5 [I/Y] 1 [PMT] [CPT] [N]
Result is 23.00.
Solution 8.22
D Section 8.04, Decreasing Annuity
10  a10 10  7.7217
5  (Da)10  5   5  5  45.5653  227.83
0.05 0.05
Alternatively, using the PIn method, we have:
P1  50 I  5 n  20
 I In n  5  1  (1.05)10 5  10
PV0   P1   an  v   50    (1.05)10
 i i  0.05  0.05 0.05
 50  7.7217  613.9233
 227.83
10 [N] 5 [I/Y] 50 [] 5 [] 0.05 [=] [PMT]
5 [] 10 [] 0.05 [=] [FV]
[CPT] [PV]

Solution 8.23
E Section 8.04, Decreasing Annuity
10(1.05)10  s10 10(1.05)10  12.5779
5  (Ds)10  5   5  5  74.2211
0.05 0.05
 371.11
Alternatively, we can use the PIn method to find the present value and then accumulate
the present value for 10 years to obtain the accumulated value:
P1  50 I  5 n  10
 I In n  5  1  (1.05)10 5  10
PV0   P1   an  v   50    (1.05)10
 i  i  0.05  0.05 0.05
 50  7.7217  613.9233
 227.8265
AV10  227.8265  1.0510  371.11
10 [N] 5 [I/Y] 50 [] 5 [] 0.05 [=] [PMT]
5 [] 10 [] 0.05 [=] [FV]
[CPT] [PV]
0 [PMT] [CPT] [FV]
Answer is 371.11.
Solution 8.24
C Section 8.04, Decreasing Annuities
We first find the present value of the otherwise equivalent annuity-immediate and then
accumulate for one year to obtain the value of the annuity-due.
P1  500 I  25 n  20
 I In n  25  1  (1.06)20 25  20
P
 1   a  v   500    (1.06)20
 i n i  0.06  0.06 0.06
 83.3333  11.4699  2,598.3727
 3,554.1995
The annuity is actually an annuity-due, however, so we multiply by 1.06 to obtain the
value of an annuity that makes each payment one year earlier than the annuity-
immediate:
1.06  3,554.1995  3, 767.45
20 [N] 6 [I/Y] 500 [] 25 [] 0.06 [=] [PMT]
25 [] 20 [] 0.06 [=] [FV]
[CPT] [PV]

(Result is 3,554.1995)
[] 1.06 [=]
Solution 8.25
A Section 8.04, Decreasing Annuity
The value of the level perpetuity-due can be used to find the annual effective interest
rate:
1
21  1 
i
i  0.05
The value of the decreasing annuity-immediate can be used to find X. Let’s use the PIn
method:
P1  X I  1 n  10
We have:
 I In n
PV0   P1   an  v
 i  i
 1  1  (1.05)10 1  10
68.73   X    (1.05)10
 0.05  0.05 0.05
68.73  ( X  20)  7.7217  122.7827
X  13
The first payment is 13, and after 7 decreases of 1, the 8th payment is:
13  7  1  6
Solution 8.26
E Section 8.04, Decreasing Annuities
At time 20, the present value of the remaining payments can be found using the PIn
method:
P1  29 I  1 n  29
 I In n  1  1  (1.09)29 1  29
PV20   P1   an  v   29    (1.09)29
 i  i  0.09  0.09 0.09
 17.8889  10.1983  26.4720  208.9080
Discounting the present value found above for 20 years and adding the present value of
the first 20 payments gives us the present value of the annuity-immediate:
208.9080 1  1.0920
208.9080v 20  30a20   30   311.13
1.0920 0.09
29 [N] 9 [I/Y] 29 [] 1 [] 0.09 [=] [PMT]
1 [] 29 [] 0.09 [=] [FV]
[CPT] [PV]
(Result is 208.9080)
[+/-] [FV]

20 [N] 30 [PMT]
[CPT] [PV]
Solution 8.27
E Section 8.04, Decreasing Annuities
The decreasing annuity is payable quarterly, and the annual rate of payment in the final
year is 20:
n  an 5  a5
20  (Da)(m)  20   20 
n i(m) i(4)
4
 0.08 
i  1    1  0.08243
 4 
5  a5 5 11.0220
0.08243 5  3.9672
20   20   20   20  12.9094
(4) 0.08 0.08
i
 258.19
1.02 [yx] 4 [] 1 [=] [] 100 [=] [I/Y]
5 [N] 1 [PMT] [CPT] [PV]
[+] 5 [=] [] 0.08 [] 20 [=]
Answer is 258.19.
Alternatively, we can use the PIn method. The annual effective interest rate is:
4
 0.08 
1    1  0.082432
 4 
The first payments are made at a rate of 100 per year, and the payments subsequently
decrease by 20 per year:
P1  100 I  20 n5 i  0.082432
If the annuity paid at the end of each year, the present value would be:
 I In n
 P1   an  v
 i i
 20  1  (1.082432)5 (20)  5
 100    (1.082432)5
 0.082432  0.082432 0.082432
 142.6238  3.9672  816.3942  250.5706
Since the annuity pays at the end of each quarter, we multiply by an adjustment factor:
i 0.082432
PV0  s(4)  250.5706   250.5706   250.5706  258.19
1 (4) 0.08
i
0.08 [] 4 [] 1 [=] [yx] 4 [] 1 [=] [STO] 1
5 [N] [RCL] 1 [] 100 [=] [I/Y] 100 [] 20 [] [RCL] 1 [=] [PMT]
20 [] 5 [] [RCL] 1 [=] [FV]

[CPT] [PV] Result is 250.5706.

[] 0.08 [] [RCL] 1 [=]
Result is -258.1885. Answer is 258.19.
Solution 8.28
D Section 8.04, Decreasing Annuities
0.03
 0.0025
12
P1  600 I  10 n  60 i  0.0025
 I In n
PV0   P1   an  v
 i i
 10  1  (1.0025)60 10  60
  600    (1.0025)60
 0.0025  0.0025 0.0025
 3, 400  55.6524  206, 608.5854  17, 390.57
0.03 [] 12 [=] [STO] 1
60 [N] [RCL] 1 [] 100 [=] [I/Y] 600 [] 10 [] [RCL] 1 [=] [PMT]
10 [] 60 [] [RCL] 1 [=] [FV]
[CPT] [PV]
Alternatively, we can answer this question using the formula for a decreasing annuity-
immediate by setting the time unit to one month:
n  an 60  a60 0.0025 60  55.6524
10  (Da)60  10   10   10 
i 0.0025 0.0025
 10  1, 739.05693  17, 390.67
Solution 8.29
E Section 8.04, Continuous Decreasing Annuity
The present value of an annuity that pays continuously at a rate of n during the first year,
(n  1) during the second year, and so on until paying at a rate of 1 in the nth year is:
n  an
(Da)n 
r
The present value of the annuity described in this question is:
10  1 e 100.07
n  an 10  a10 e0.07 1
50  (Da)n  50   50   50 
r 0.07 0.07
10  6.9429
 50   50  43.6733  2,183.67
0.07
0.07 [2nd] [ex] [] 1 [=] [] 100 [=] [I/Y]
10 [N] 1 [PMT] [CPT] [PV]

[+] 10 [=] [] 0.07 [=]

Result is 43.6733.
[] 50 [=]
Answer is 2,183.67.
Alternatively, we can use the PIn method to obtain the present value of a decreasing
annuity-immediate:
10  a10
50  (Da)10  50 
i
Then, we can multiply by the ratio i/r to obtain the present value of the continuously
payable annuity:
i 10  a10 10  a10
 50   50   50  (Da)n
r i r
P1  500 I  50 n  10 i  e0.07  1  0.0725
0.07 [2nd] [ex] [] 1 [=] [STO] 1
10 [N] [RCL] 1 [] 100 [=] [I/Y] 500 [] 50 [] [RCL] 1 [=] [PMT]
50 [] 10 [] [RCL] 1 [=] [FV]
[CPT] [PV]
Result is PV = 2,108.1293.
[] [RCL] 1 [] 0.07 [=]
Solution 8.30
At time 20, the present value of the remaining payments can be found using the PIn
method:
P1  28 I  2 n  14
 I In n  2  1  (1.09)14 2  14
PV20   P1   an  v   28    (1.09)14
 i  i  0.09  0.09 0.09
 5.7778  7.7862  93.0989  138.0855
Discounting the present value found above for 20 years and adding the present value of
the first 20 payments gives us the present value of the annuity-immediate:
138.0855 1  1.0920
138.08550v 20  30a20   30   298.50
1.0920 0.09
14 [N] 9 [I/Y] 28 [] 2 [] 0.09 [=] [PMT]
2 [] 14 [] 0.09 [=] [FV]
[CPT] [PV]
(Result is 138.0855)
[+/-] [FV]

20 [N] 30 [PMT]
[CPT] [PV]
Solution 8.31
1, 000(0.07)  100 1.059  900(0.07)  100 1.058    100(0.07)  100
 170  1.059  163  1.098    107
P1  170 I  7 n  10
 I In n  7  1  (1.05)10 7  10
PV0   P1   an  v   170    (1.05)10
 i i  0.05  0.05 0.05
 30  7.7217  859.4786  1, 091.1306
1, 091.1306  1.0510  1, 777.34
10 [N] 5 [I/Y] 170 [] 7 [] 0.05 [=] [PMT]
7 [] 10 [] 0.05 [=] [FV]
[CPT] [PV]
Result is 1,091.1306.
0 [PMT]
[CPT] [FV] Answer = 1,777.34

Chapter 9: Continuously Payable Varying
Payments
Solution 9.01
B Section 9.02, Continuous Annuities, Decreasing Continuously
In the formula for a continuously increasing annuity, we replace the continuously
compounded interest rate with 1/n:
enr  1 en(1/ n)  1
 n n
s n r (1 / n) n(e  1)  n ne  n  n
(Is )n  n      n(ne  2n)
r r (1 / n) 1/n 1/n
 n2 (e  2)
Solution 9.02
E Section 9.01, Continuously Varying Payment Stream
The equation of value at time 12 is:
b b
Pmtt e t
rs ds
AVb   dt
a
12
12 (7  s)1 ds
22, 344  0 k(7  t )e t dt
We begin by evaluating the integral in the exponent:

12 12  19 
t (7  s)1 ds  ln(7  s)
t
 ln(19)  ln(7  t )  ln  
7  t 
The equation of value can now be used to solve for k:
12  19 
22, 344  0 k(7  t )   dt
7  t 
12
22, 344  0 19kdt
22, 344  k(228  0)

k  98
Solution 9.03
D Section 9.02, Continuous Annuities, Increasing Continuously
The present value of the perpetuity is:
 an  nv n   1v n  nv n 
Lim 3  (Ia)n   Lim 3  
  Lim 3  r  3
n  n   r  n   r  r2
   
3
  1, 260.25
2
ln(1.05)

Chapter 9: Continuously Payable Varying Payments Solutions to End of Chapter Questions
Solution 9.04
D Section 9.02, Continuous Annuities, Increasing Continuously
1.0510  1
sn  n  10
ln(1.05) 12.8898  10
3  (Is )n  3  3  3
r ln(1.05) ln(1.05)
 3  59.2288  177.69
Alternatively, we can find the accumulated value using integration:
10
AV10  0 3t(1.05)10  t dt
Let’s use integration by parts:
 3t(1.05)  udv
10  t
dt 
where: u  3t dv  (1.05)10  t dt
We have:
(1.05)10  t
u  3t v 
ln(1.05)
du  3dt dv  (1.05)10  t dt
We can now find the integral:
 3t(1.05)  udv  uv   vdu

10  t
dt 
(1.05)10  t (1.05)10  t (1.05)10  t 3(1.05)10  t

 3t
ln(1.05)
 3 
ln(1.05)
dt  3t
ln(1.05)

[ln(1.05)]2
10
10  (1.05)10  t 3(1.05)10  t 
0
10  t
AV10  3t(1.05) dt   3t  
 ln(1.05) [ln(1.05)]2 0
 30 3   3(1.05)10 
     0  
 ln(1.05) [ln(1.05)]2   [ln(1.05)]2 
 1, 875.1280  2, 052.8144  177.69
Solution 9.05
A Section 9.02, Continuous Annuities, Decreasing Continuously
The present value of an annuity that pays continuously at a rate of (30 – 3t) at time t for
10 years is equal to the value of a level annuity minus the value of an increasing annuity:
1  v10 a  10v10
PV0  30a10  3(Ia)10  30   3  10
r r
1  1.0510 a  10  1.0510
 30   3  10
ln(1.05) ln(1.05)
7.9132  10  1.0510
 30  7.9132  3   237.3963  3  36.3613
ln(1.05)
 128.3122

Alternatively, we can find the present value of the annuity using integration:
10
PV0  0 (30  3t )(1.05)t dt
Let’s use integration by parts:
 (30  3t )(1.05)  udv

t
dt 
where: u  30  3t dv  (1.05)t dt
We have:
(1.05)t
u  30  3t v 
ln(1.05)
du  3dt dv  (1.05)t dt
We can now find the integral:
 (30  3t )(1.05)  udv  uv   vdu

t
dt 
(1.05)t (1.05)t (1.05)t 3(1.05)t

 (30  3t )
ln(1.05)
 3 
ln(1.05)
dt  (3t  30) 
ln(1.05) [ln(1.05)]2

10
10  (1.05)t 3(1.05)t 
PV0  
0
(30  3t )(1.05)t dt  (3t  30)

 
ln(1.05) [ln(1.05)]2 
0
 3(1.05)10   30 3 
 0    
2 2
 [ln(1.05)]   ln(1.05) [ln(1.05)] 
 773.6842  645.3719  128.3122
Solution 9.06
C Section 9.01, Continuously Varying Payment Stream
t
8 8
(30t  20)e 0
 (0.03s  0.02)ds 2
PV0  0 dt  0
(30t  20)e(0.015t  0.02t )dt
Let’s use substitution:

u  0.015t 2  0.02t du  (0.03t  0.02)dt
We have:
(0.015t 2  0.02t ) 2
 (30t  20)e 
dt  1, 000 (0.03t  0.02)e (0.015t  0.02t )dt
 1, 000 e u du  1, 000e u

2
 1, 000e (0.015t  0.02t )
8
t 8
(30t  20)e 0
 (0.03s  0.02)ds  2 
PV0  
0
dt   1, 000e (0.015t  0.02t ) 
 0
  1, 000e (0.01564  0.028)    1, 000e0 
   
 326.280  1, 000  673.7202

Solution 9.07
A Section 9.01, Continuously Varying Payment Stream
The present value at time 5:
t
10  (0.006 s2  0.04s)ds
PV5  5 (3t 2  20t )e 5 dt
t
10  0.002s3  0.02s2 
 5
5
2
 (3t  20t )e dt
10 3 2
 5 (3t 2  20t )e (0.002t 0.02t  0.002125  0.0225)dt
10 3 2
 5 (3t 2  20t )e(0.75  0.002t  0.02t )dt

u  0.75  0.002t 3  0.02t 2 du  (0.006t 2  0.04t )dt
We have:
3 2
 (3t
2
 20t )e(0.75  0.002t  0.02t )dt
3 2

 500 (0.006t 2  0.04t )e(0.75  0.002t  0.02t )dt

 500 eu du  500eu
3 2
 500e(0.75  0.002t  0.02t )
3 2
10
PV5   500e(0.75  0.002t  0.02t )  500 e3.25  e0   500 1  e 3.25 
5
   
 480.6129
PV0  480.6129e50.05  374.30
Solution 9.08
C Section 9.01, Continuously Payable Annuity
Let’s break the perpetuity into two parts.
The first part consists of the payments made in the first 20 years. The present value of
the first part is:
1  v n 1  1.0820
a20    10.2058
r ln(1.08)
The second part consists of the payments made after 20 years. The formula for the
present value of a continuously payable annuity is:
b t
Pmtt e a s dt
 r ds
PVa  
a

The present value at time 20 of the payments made after 20 years is:
 t 
1.05t 20 e 20
 ln(1.08)ds
  1.05
t 20  ln(1.08)(t 20)
PV20  dt  e dt
20 20

 1.05
t 20
  1.0820  t dt
20

20  t 20 t
 1.08   1.05   1.08   1.05  1
 
 1.05 
  1.08  dt   
 1.05 

 1.08

 ln 1.05
 
20 1.08 20
20 20
 1.08   1.05  1 1
0      35.4977
 1.05   1.08  ln  1.05
1.08  1.05
ln 1.08 
The present value at time 0 of the payments made after 20 years is the present value at
time 20, discounted for 20 years:
20 20
 1   1 
PV0    PV20    35.4977  7.6160
 1.08   1.08 
The present value of the perpetuity is equal to the sum of the present values of the two
parts of the perpetuity:
10.2058  7.6160  17.8218
Solution 9.09
B Section 9.02, Continuously Payable Annuity
The payments begin at an annual rate of 0 at time 0, increase to an annual rate of 50 at
time 5, and then decrease back to 0 at time 10.
The present of the payments over the first 5 years is:
1v 5  5v 5 4.4368  5
a5  5v 5 ln(1.05) 1.055
10(Ia)5  10   10   10   10  10.6415
r r ln(1.05)
 106.4154
After 5 years, the rate of payment is 50 and it steadily decreases thereafter. This can be
valued at time 5 with an annuity that pays at a constant rate of 50 minus an increasing
annuity that increases at a rate of 10 per year. To find the value at time 0, we discount
for 5 years. The present value of the payments over the final 5 years is therefore:
50a5  10(Ia)5  v5  50  4.4368  10  10.6415 1.055  115.4262

1.055
 90.4395
The present value of the entire payment stream is:
 
PV0  10(Ia)5  50a5  10(Ia)5 v 5  106.4154  90.4395  196.8549
Solution 9.10
A Section 9.01, Continuously Varying Payment Stream
t
4  0.001s3ds
PV0  0 3t 3e 0 dt

The integral in the exponent is:

t
t s4 t4

3
 0.001s ds   0.001  0.001
0 4 4
0
t4
u  0.001 du  0.001t 3dt
4
We have:
t t 4 t 4
4  0.001s3ds 4 t 4 3 3
PV0  0 3t 3e 0 dt  0
3 0.001 4
3t e dt  t 0  eu du   eu
0.001 0.001 t 0
4
t 4

3
0.001
e
0.001 t
4 
3
0.001
e0.064 
3
0.001

 3, 000 1  e 0.064  185.99 
t 0

Chapter 10: Geometric Progression
Annuities
Solution 10.01
D Section 10.02, Geometric Annuity Formulas
We begin by finding j:
1i 1.04
j  1   1  0.07143
1 g 1.12
10
  100  1  (1  0.07143)
PV0  100a  100  14.2766  1, 427.6597
nj 0.07143
1 0.07143

AV10  (1  i )10  PV0  (1.04)10  1, 427.6597  2,113.29
1.04 [] 1.12 [] 1 [=] [] 100 [=] [I/Y]
10 [N] 100 [PMT] [CPT] [PV]
Result is 1,427.6597.
0 [PMT] 4 [I/Y] [CPT] [FV]
Answer is 2,113.29.
Alternatively, we can find the accumulated value using the formula for the sum of a
geometric series:
AV10  100(1.04)10  100(1.04)9 (1.12)    100(1.04)(1.12)9
First term  Term that would come next

1  Ratio
100(1.04)10  100(1.12)10
  100  21.1329  2,113.29
1.12
1
1.04
Solution 10.02
A Section 10.02, Geometric Annuity Formulas
Let’s use one quarter as our unit of time and use i to represent the effective interest rate
for one unit of time:
i  1.100.25  1  0.02411
We can now determine j, using the growth rate and the interest rate applicable to one
quarter:
1i 1.02411
j  1   1  0.004033
1 g 1.02

Chapter 10: Geometric Progression Annuities Solutions to End of Chapter Questions

100a
nj 100 1  (1.004033)40 100
PV0      37.0205
1 i 1.02411 0.004033 1.02411
1.004033
 3, 614.88
1.10 [yx] 0.25 [=] [STO] 1
[] 1.02 [] 1 [=] [] 100 [=] [I/Y]
40 [N] 100 [PMT] [CPT] [PV]
Result is 3,702.0531.
[] [RCL] 1 [=]
Alternatively, we can find the present value using the formula for the sum of a geometric
series. Below we define v to be the discount factor for one quarter:
PV0  100v  100v 2 (1.02)    100v 40 (1.02)39

1  Ratio
40
100 100  1.02 

41
100v  100v (1.02)40
1.02411 1.02411  1.02411 
 
1  1.02v 1.02
1
1.02411
40
 1.02 
1 

100
  1.02411  
100
 37.0205
1.02411 1.02 1.02411
1
1.02411
 3, 614.88
Solution 10.03
D Section 10.02, Geometric Annuity Formulas
Let’s use one quarter as our unit of time and use i to represent the effective interest rate
for one unit of time:
i  1.100.25  1  0.02411
We can now determine j, using the growth rate and the interest rate applicable to one
quarter:
1i 1.02411
j  1   1  0.04501
1 g 1  0.02
100a
nj 100 1  (1.04501)40 100
PV0      19.2261
1 i 1.02411 0.04501 1.02411
1.04501
 1, 877.3383
AV10  (1.10)10  PV0  (1.10)10  1, 877.3383  4, 869.33


1.10 [yx] 0.25 [=] [STO] 1
[] 0.98 [] 1 [=] [] 100 [=] [I/Y]
40 [N] 100 [PMT] [CPT] [PV]
Result is 1,922.6079.
[] [RCL] 1 [=]
Result is 1,877.3383.
[] [RCL] 1 [yx] 40 [=]
Alternatively, we can find the accumulated value using the formula for the sum of a
geometric series:
AV10  100(1.02411)39  100(1.02411)38 (0.98)    100(0.98)39

1  Ratio
39 100
100(1.02411)  (0.98)40
 1.02411  100  48.6933
0.98
1
1.02411
 4, 869.33
Solution 10.04
A Section 10.02, Geometric Annuity Formulas
i  er  1  e0.07  1  0.07251
We find j:
1i 1.07251
j  1   1  0.04127
1 g 1.03
  36  Lim 1  (1.04127)n 1
PV0  Lim 36a nj
 36   908.30
n  n  0.04127 0.04127
1.04127 1.04127
Alternatively, we can find the present value using the formula for the sum of a geometric
series:
2
 1.03   1.03 
PV0  36  36   36   
0.07 
e   e0.07 

1  Ratio
36  0
  908.30
1.03
1
e0.07

Solution 10.05
B Section 10.02, Geometric Varying Annuities
The 20 payments are described below:
Time Payment
0 100
1 100  1.10
2 100  1.102
 
9 100  1.109
10 100  1.109  0.90
11 100  1.109  0.902
 
19 100  1.109  0.9010
Let’s begin by finding the present value of the first 10 payments:
 1.10
1.04 
10
1
100  100(1.10)v    100(1.10)9 v 9  100   1, 303.8817
1 1.10
1.04
The present value of the second set of 10 payments is:

100(1.10)9 v10 (0.90)  100(1.10)9 v11(0.90)2    100(1.10)9 v19 (0.90)10
 
10
0.90
1  1.04
 100(1.10)9 v10 (0.90)   814.1323
1 0.90
1.04
The present value of the payments is the sum of the present value of the first 10
payments and the second 10 payments:
1, 303.8817  814.1323  2,118.01
Solution 10.06
E Section 10.02, Geometric Progression Annuities
Time Payment
1 4, 000  1.08
2 4, 000  1.082
3 4, 000  1.083
 
15 4, 000  1.0815


4, 000  1.08v  4, 000  1.082 v 2    4, 000  1.0815 v15
16
1.08  1.08 

1.06  1.06 
 4, 000   69, 905.23
1.08
1
1.06
Solution 10.07
C Section 10.02, Geometric Varying Annuities
At the end of 10 years, the value of the perpetuity’s remaining payments is equal to the
value of the 20-year annuity-immediate:
200
0.04

 X v  1.04v 2  1.042 v 3    1.0419 v 20 
200  1  1 
2 3 20 
2 1  19  1 
 X  1.04    1.04      1.04   
0.04  1.04  1.04   1.04   1.04  
 
200  20 
 X 
0.04  1.04 
200 1.04
X  
0.04 20
X  260
Alternatively, we can write the equation of value at the end of 10 years as follows:

a
200 20 j 1 i 1.04
 X where j  1  1  0
0.04 1.04 1 g 1.04
200  20 
 X 
0.04  1.04 
200 1.04
X  
0.04 20
X  260

Solution 10.08
B Section 10.02, Geometric Progression Annuities
The present value of the perpetuity-immediate is 486.26:
20v  20v 2  20v 3  20v 4  20 v 5  (1  K )v 6  (1  K )2 v 7    486.26
 
v5  0
20a4  20   486.26
1 K
1
1.08
1  1.084 v5
20   20   486.26
0.08 1 K
1
1.08
v5
20  3.3121  20   486.26
1 K
1
1.08
1
 30.8572
1K
1
1.08
K  0.0450
The question referred to K% instead of K, so we multiply the value of K found above by
100:
0.0450  100  4.50
Solution 10.09
B Section 10.02, Geometric Progression Annuities
There are 48 monthly payments. We use one month as the unit of time:
0.06
i   0.005
12
1
v 
1.005
Time Payment
1 10, 000
2 10, 000  0.99
3 10, 000  0.992

 
38 10, 000  0.9937
39 1, 000  0.9938
 
48 1, 000  0.9947

The outstanding balance after the 38th payment is the present value of the payments after
the 38th payment:
PV38  10, 000  0.9938 v  10, 000  0.9939 v 2    10, 000  0.9947 v10
10
 0.99 
10 10 1 
 10, 000  0.9938 v 
1  0.99 v
 10, 000  0.9938 v   1.005 
1  0.99v 0.99
1
1.005
 63, 531.26
Solution 10.10
A Section 10.02, Geometric Progression Annuities
Time Payment
1 3, 000
2 3, 000  1.04
3 3, 000  1.042
 
8 3, 000  1.047
9 3, 000  1.047  0.96

10 3, 000  1.047  0.962
 
18 3, 000  1.047  0.9610

PV0  3, 000v  3, 000v 2  1.04    3, 000v 8  1.047
3, 000  1.047 v 8 0.96v  0.962 v 2    0.9610 v10 
 
v  1.048 v 9 0.96v  0.9611v11
 3, 000   3, 000  1.047 v 8 
1  1.04v 1  0.96v
 3, 000  7.0671  2, 476.8956  6.0361
 21, 201.4270  14, 950.8019
 36,152.23
Solution 10.11
C Section 10.02, Geometric Progression Annuities
0.09
 0.0075
12
1.007512  1  0.09381

The present value of the first year’s payments is:

1  1.007512
600a12 0.0075  600   6, 860.9476
0.0075
The payments in the 14 subsequent years increase by 3% per year:
15
 1.03 
1 
X  6, 860.9476 1  1.03v    (1.03v )14   6, 860.9476   1.09381 
  1.03
1
1.09381
 6, 860.9476  10.1839  69, 870.94
Solution 10.12
E Section 10.02, Geometric Progression Annuity
The equation of value after 25 years can be used to solve for i:
2, 000 (1  i )24  (1  i )23(1  g)    (1  g)24 
 
 1 g 1  g  
24
 7,395.44 1    
 1i  1  i  
 
 1 g
24 
1  g    1 g  1  g  
24
2, 000(1  i )24 1      7,395.44 1     1 i 
 1 i  1  i    1 i   
 
2, 000(1  i )24  7,395.44
1/24
 7,395.44 
(1  i )   
 2, 000 
i  0.05600
Alternatively, we can use the formula for the present value of an annuity-immediate that
increases geometrically:

a 25 j 1 i
PV0  where: 1  j 
1 i 1 g
The following time-25 equation of value can be used to solve for i:

a 25 j
2, 000   (1  i )25  7,395.44  a

25 j
1 i
2, 000(1  i )24  7,395.44
1/24
 7,395.44 
(1  i )   
 2, 000 
i  0.05600

Solution 10.13
D Section 10.02, Geometric Progression Annuity
We begin by noting that:
1.042  1.0816
(v  v 2 )  1.0816(v 3  v 4 )  1.08162 (v 5  v 6 )  1.08163(v 7  v 8 )  1.08164 (v 9  v10 )
 (v  v 2 ) 1  1.0816v 2  1.08162 v 4  1.08163v 6  1.08164 v 8 
 
 2 2 4 3 6
 a2 1  1.0816v  1.0816 v  1.0816 v  1.0816 v 4 8
 
 1.0816 1.08162 1.08163 1.08164 
 a2 1     
 1.042 1.044 1.046 1.048 
 a2 1  1  1  1  1
 5a2
Solution 10.14
A Section 10.02, Geometric Progression Annuity
We begin by noting that:
1.042  1.0816
a4 1  1.0816v 4  1.08162 v 8  1.08163 v12  1.08164 v16 
 
 1.0816 1.0816 2
1.0816 3
1.0816 
4
 a4 1     
4 8 12
 1.04 1.04 1.04 1.0416 
 1.042 1.044 1.046 1.048 
 a4 1     
 1.044 1.048 1.0412 1.0416 
 a4 1  v 2  v 4  v 6  v 8 
 
 1  v10 
 a4  
2
 1  v 
If we divide both the numerator and the denominator of the fraction in the final
expression above by the effective interest rate, then we obtain the ratio of two immediate
annuities:
 1v10  1v 4
 1  v10   a  a10   a4  a  0.04  a  1  v  a
4
a4 
2
  a4  0.042  4 10 10 10
1  v2
2
 1  v  1v
 0.04   a2  a2 1v
0.04
 (1 + v 2 )a10

Solution 10.15
C Section 10.02, Geometric Progression Annuity
The equation of value after 25 years can be used to solve for i:
2, 000 (1  i )24  (1  i )23(1.02)    (1.02)24 
 
 1.02  1.02 
24 
 7,395.44 1     
 1 i  1  i  

 1.02  1.02  
24  1.02  1.02  
24
2, 000(1  i )24 1      7,395.44 1     1 i 
 1 i  1  i    1 i   
 
2, 000(1  i )24  7,395.44
1/24
 7,395.44 
(1  i )   
 2, 000 
i  0.05600
The account balance after the final deposit is equal to the value of the future deposits at
the time of retirement:
25
 1.02 
 1 
 1.02  
24
7,395.44 1 
1.02
   7,395.44   1.05600 
1 i  1.02

  1  i   1
1.05600
 7,395.44  17.0089  125, 788.13
Solution 10.16
E Section 10.02, Geometric Progression Perpetuity
We can use the formula for the present value of a geometric progression perpetuity to find
the interest rate:
Pmt1
PV0 
ig
7
175 
i  0.02
175i  3.5  7
i  0.06

Solution 10.17
E Section 10.02, Geometric Progression Perpetuity
The equation of value at time 0 can be used to solve for i. To find the present value of the
payments received by the company, we can use the formula for the present value of a
geometric progression perpetuity:
130 100
1, 000  
i i  0.03
1, 000i(i  0.03)  130(i  0.03)  100i
1, 000i 2  30i  130i  3.9  100i  0
1, 000i 2  3.9
3.9
i 
1, 000
i  0.0624
Solution 10.18
B Section 10.02, Geometric Progression Perpetuity
We can use the formula for the present value of a geometric progression perpetuity.
The rate of growth of the quarterly payments is:
1,704.25
 1  0.0025
1, 700
The present value of the payments can be used to solve for the quarterly effective interest
rate:
1,704.25
316, 965.95  1, 700  (4)
i  0.0025
4
i(4)
 0.007905
4
4
 i(4) 
1    1  1.0079054  1  0.0320
 4 
 
Solution 10.19
C Section 10.02, Geometric Progression Perpetuity
At the end of 20 years, the present value of the remaining payments is found using the
formula for the present value of a geometric progression perpetuity:
4(1.01)
PV20   101
0.05  0.01

The present value of the payments at time 0 is:

PV0  2a10  4a10  v10  101v 20
 
 2  4v10 a10  101v 20
 4  1  1.0510 101
 2  
10 
 1.05  0.05 1.0520
 (4.4557)7.7217  38.0658
 72.47
Solution 10.20
B Section 10.02, Geometric Progression Perpetuity
Let PmtN be the next payment of Perpetuity N. The value of Perpetuity M is 3 times the
value of Perpetuity N:
Value of Perpetuity M  3  (Value of Perpetuity N)
(1 / 3)PmtN PmtN
 3
0.07  g 0.07  (g)
1 1
 9
0.07  g 0.07  g
9(0.07  g)  0.07  g
0.56  10g
g  0.0560

Chapter 11: Loans
Solution 11.01
A Section 11.02, Level Payment Amortized Loans
After the 15th payment, the remaining balance is equal to the present value of the
remaining 30 payments:
400a30
After subtracting out the extra 2,000, the remaining balance is:
400a30  2, 000
This balance is then paid off with 25 payments, so the time-15 equation of value is:
400a30  2, 000  X  a25
We can now solve for the revised annual payment:

1  1.0730 1  1.0725
400   2, 000  X 
0.07 0.07
400  12.4090  2, 000  X  11.6536
X  254.31
The BA-II Plus calculator can be used to solve this problem as follows:
45 [] 15 [=] [N] 7 [I/Y] 400 [PMT] [CPT] [PV]
[+] 2,000 [=] [PV] 25 [N]
[CPT] [PMT]
Result is 254.31.
Solution 11.02
A Section 11.02, Level Payment Amortized Loans
The payment of 14 is exactly equal to the interest on the loan each quarter:
0.08
700   14
4
Since the payment does not exceed the interest, the amount of principal paid down is zero
for each payment:
Prnt  Pmtt  Intt  14  14  0
Solution 11.03
E Section 11.02, Level Payment Amortized Loans
The amount of each level payment is:
Pmt  73.09  426.91  500
The principal repaid in the 17th payment is found below:
Prnt  k
 (1  i )k
Prnt
Prn17
 (1.06)12
73.09
Prn17  147.0714

Chapter 11: Loans Solutions to End of Chapter Questions
The interest paid in the 17th payment is the payment minus the principal paid:
500  147.0714  352.93
Solution 11.04
The interest paid on the first loan is:
 
4, 000  1.0410  1  1, 920.9771
The interest paid on the second loan is:

4, 000  10  0.04  1, 600
The interest paid on the third loan is the sum of the 10 payments minus the total principal
paid. The total principal paid is equal to the initial principal of 4,000:
4, 000 4, 000
 10  4, 000   10  4, 000  493.1638  10  4, 000
a10 0.04 8.1109
 931.6378
The total amount of interest paid on all 3 loans is:
1, 920.9771  1, 600  931.6378  4, 452.6149
Solution 11.05
B Section 11.02, Level Payment Amortized Loans
The first 5 payments pay the principal down at a rate that is equal to 100% of the interest
rate. Since the interest rate is 10%, the portion of the principal that is paid down by each
of the first 10 payments is:
(200%  100%)  0.10  0.10
After 5 years, the original principal has been reduced by 10% per year for 5 years. The
equation of value at the end of 5 years is:
10, 000  0.905  Xa5 0.10
1  1.105
5, 904.90  X 
0.10
X  1, 557.70
The BA-II Plus can be used to answer this question:
10,000 [] 0.9 [yx] 5 [=] [PV]
5 [N] 10 [I/Y] [CPT] [PMT]
Result is 1,557.70. Solution is 1,557.70.
Solution 11.06
The following formulas are useful for answering this question:
Intt  (1  v n  t 1 )Pmt
Prnt  v n  t 1  Pmt

Substituting 1 for the level payment amount, the sum of the principal paid in year t and
the interest paid in year (t  1) is:
 
X  Prnt  Intt 1  v n  t 1  1  v n (t 1)1  1  v n  t 1  v n  t
 1  v n  t (v  1)  1  v n  t (1  v )  1  v n  t d
The answer is Choice E.
Solution 11.07
C Section 11.02, Level Payment Amortized Loans
The final payment is the loan balance at the end of year 4 accrued with interest:
Pmt  911.74  1.07  975.5618
The initial loan balance is:
1  1.075
Pmt  a5  975.5618   3, 999.9960
0.07
The first principal payment is equal to the level payment minus the interest on the initial
loan balance:
975.5618  3, 999.9960  0.07  695.56
Solution 11.08
D Section 11.02, Level Payment Amortized Loans
The principal payment increases by (1 + i) each year:
Prnt  k
 (1  i )k
Prnt
Prn6
 (1.07)5
Prn1
1, 015.13
 (1.07)5
Prn1
Prn1  723.77
Solution 11.09
C Section 11.02, Level Payment Amortized Loans
0.10
 0.008333
12
The initial loan payment is:
500, 000 500, 000 500, 000
Pmt     5,373.0256
a1512 0.008333 180 93.0574
1  1.008333
0.008333
The balance after the 48th payment can be found using the prospective method. At the
new interest rate, the smaller payments pay off the balance in 11 years:
5, 373.0256  a132 0.008333  (5,373.0256  473.98)a132 i /12
5, 373.0256  79.8730  4, 899.0456  a132 i /12
429,159.5981  4, 899.0456  a132 i /12

The easiest way to find i is to use the BA II Plus calculator. Let’s use the calculator from
the beginning of this question:
180 [N] 10 [] 12 [=] [I/Y] 500,000 [+/-] [PV] [CPT] [PMT]
Result is 5,373.0256.
11 [] 12 [=] [N] [CPT] [PV]
Result is 429,159.5981.
[RCL] [PMT] [] 473.98 [=] [PMT] [CPT] [I/Y] [] 12 [=]
Result is 8.00. Answer is 8.00%.
Solution 11.10
B Section 11.02, Level Payment Amortized Loans
The monthly effective rate at which the loan is originally made is:
0.09
 0.0075
12
The original payment amount is:
75, 000
 674.7945
a240 0.0075
After the 24th payment, the remaining balance can be found using the prospective
method:
L24  674.7945  a240 24 0.0075  72, 059.1797
The new payment amount is the amount needed to pay off the remaining balance at the
new interest rate of 7% compounded monthly:
72, 059.1797 72, 059.1797
  587.64
a 0.07 a216 0.005833
240 24
12
Alternatively, we can use the BA II Plus to answer this question:

240 [N] 9 [] 12 [=] [I/Y] 75,000 [+/-] [PV] [CPT] [PMT]
Result is 674.7945.
240 [] 24 [=] [N] [CPT] [PV]
Result is 72,059.1797.
7 [] 12 [=] [I/Y] [CPT] [PMT]
Answer is 587.64.
Solution 11.11
0.06
i   0.06383
1  0.06
We can solve for the amount of the 5 level payments:
24, 000  Pmt  a5 0.06383
24, 000  Pmt  4.1688
Pmt  5, 757.0013

If the first 4 payments were instead 5,800, then the balance at the end of 4 years would
be:
24, 000 24, 000
 5, 800  s4 0.06383   5, 800  4.3995
4
0.94 0.944
 5,222.4070
The final payment is the balance at the end of 4 years, accumulated for one additional
year of interest:
5, 222.4070
 5, 555.75
0.94
0.06 [] 0.94 [] 100 [=] [I/Y]
5 [N] 24,000 [+/-] [PV] [CPT] [PMT]
Result is 5,757.0013.
5,800 [PMT] 4 [N] [CPT] [FV]
[] 0.94 [=]
Answer is 5,555.75.
Solution 11.12
The amount of the equal annual payments under option (i) is:
10, 000 10, 000
  802.4259
a20 0.05 12.4622
Alternatively, the amount of the equal annual payments under option (i) can be found
using the BA-II Plus calculator:
20 [N] 5 [I/Y] 10,000 [+/-] [PV] [CPT] [PMT]
Result is 802.4259.
The sum of the payments under option (i) is:
802.4259  20  16, 048.5174
Since the payments of 500 under option (ii) are over and above the payment of the
interest, the balance of the loan decreases by 500 per year. Therefore, the interest
payments decline each year. The sum of the payments under option (ii) is:
500  20  i(10, 000  9,500    500)  10, 000  500i(20  19    1)
20  21
 10, 000  500i   10, 000  105, 000i
2
Setting the sum of the payments under option (i) equal to the sum of the payments under
option (ii) allows us to solve for i:
16, 048.5174  10, 000  105, 000i
6, 048.5174
i 
105, 000
i  0.0576

Solution 11.13
C Section 11.02, Level Payment Amortized Loan
We begin by finding the level payment amount:
Pmt
1, 370.65 
1.06510  6 1
Pmt  1, 877.9093
The initial value of the loan can be found using the prospective method:
1  1.06510
1, 877.9093  a10  1, 877.9093   1, 877.9093  7.1888
0.065
 13, 499.9710
The total amount of interest paid on the loan is equal to the total amount of the payments
minus the initial loan balance:
10  1, 877.9093  13, 499.9710  18,779.0929  13, 499.9710  5, 279.12
The BA II Plus can be used to answer this question:
1,370.65 [] 1.065 [yx] 5 [=]
Result is 1,877.9093.
[PMT] 10 [N] 6.5 [I/Y] [CPT] [PV]
Result is 13,499.9710.
[+] 10 [] [RCL] [PMT] [=]
Answer is 5,279.12.
Solution 11.14
B Section 11.02, Level Payment Amortized Loan
We make use of the following formula for the interest portion of a payment:
Intt  (1  v n  t 1 )Pmt
The formula can be used to find the following expressions:
Intn 2  (1  v 3 )Pmt
Intn 5  (1  v 6 )Pmt
Int1  (1  v n )Pmt
The interest portion of the payment at time (n  2) is equal to 0.5471 of the interest
portion of the payment at time (n  5), which allows us to solve for v:
(1  v 3 )Pmt  0.5471(1  v 6 )Pmt
1  0.5471(1  v 3 )
v  0.9390
The interest portion of the payment at time (n  2) is equal to 0.2209 of the interest
portion of the first payment, which allows us to solve for n:
(1  v 3 )Pmt  0.2209(1  v n )Pmt
0.1722  0.2209(1  v n )
0.2205  v n
ln(0.2205)  n  ln(v )
n  24.00

Solution 11.15
E Section 11.02, Level Payment Amortized Loan
We do not need to know the details of the payments occurring after the 16th year to
answer this question.
The principal repaid in year 16 is the payment of 1,500 minus the interest on the
outstanding balance at the end of 15 years:
X  1,500  iL15
The interest paid in the first year is the interest rate times the initial loan balance:
 
i  L0  i 1,500  a15  v15L15  1,500(1  v15 )  iv15L15
 1,500  1,500v15  iv15L15  1,500  v15 1,500  iL15 

 1,500  Xv15
The final expression above matches Choice E.
Solution 11.16
E Section 11.02, Level Payment Amortized Loan
We do not need to know the details of the payments occurring after the 11th year to
answer this question.
The principal repaid in year 11 is the payment of 1,000 minus the interest on the
outstanding balance at the end of 10 years:
X  1, 000  iL10
The interest paid in the first year is the interest rate times the initial loan balance:
 
i  L0  i 1, 000  a10  v10 L10  1, 000(1  v10 )  iv10 L10
 1, 000  1, 000v10  iv10 L10  1, 000  v10 1, 000  iL10 

 1, 000  Xv10
The final expression above matches Choice E.
Solution 11.17
C Section 11.02, Level Payment Amortized Loan
We use the following formulas:
Intt  (1  v n  t 1 )Pmt
Using the information provided in the question, we have:
Int1  (1  v 20 )Pmt  4,316
Prn11  v10  Pmt  4, 080
Dividing the first equation by the second equation allows us to solve for v:
(1  v 20 )Pmt 4,316

10 4, 080
v  Pmt
4, 080(1  v 20 )  4, 316v10
0  4, 080v 20  4, 316v10  4, 080

We can use the quadratic formula to solve for v10 :
4,316  4,3162  4  4, 080  (4, 080)

v10 
2  4, 080
v10  0.6023 or v10  1.1660
We use the positive value of v10 to solve for i:
v10  0.6023
i  0.05200
Since the interest paid in the first year is 4,316, we have:
Li  4, 316
L  0.05200  4, 316
L  83, 000.30
The answer is Choice C.
Alternatively, we can use the answer choices provided to quickly consider each possibility.
We use the calculator to divide the 1st year’s interest by the possible value of L and then
see if it produces the correct principal payment in the 11th year. We use the BA-II Plus:
20 [N]
4,316 [] 81,000 [] 100 [=] [I/Y] 81,000 [PV] [CPT] [PMT]
[2nd] [AMORT] 11 [ENTER] ↓ [ENTER] 11 ↓↓
(Result is 3,975.97, so Choice A is not correct.)
[2nd] [QUIT]
4,316 [] 81,500 [] 100 [=] [I/Y] 81,500 [PV] [CPT] [PMT]
[2nd] [AMORT] ↓↓↓
(Result is 4,001.98, so Choice B is not correct.)
[2nd] [QUIT]
4,316 [] 83,000 [] 100 [=] [I/Y] 83,000 [PV] [CPT] [PMT]
[2nd] [AMORT] ↓↓↓
(Result is 4,079.98. This rounds to 4,080 so Choice C is correct.)
[2nd] [QUIT]
Solution 11.18
A Section 11.03, Drop Payments
If we accumulate the initial loan balance to time 3, then we can treat the loan as a loan
with the first payment occurring one year later:
84, 000
 101,133.6602
(1  0.06)3
0.06
 0.06383
1  0.06

We can solve the time-3 equation of value for n:

101,133.6602  10, 000  an
1  1.06383n
101,133.6602  10, 000 
0.06383
0.3545  1.06383n
n  16.7618
Therefore, there are 16 payments of 10,000 and then a final drop payment:
101,133.6602  10, 000a16  DropPmt  0.9417
1  1.0638316
101,133.6602  10, 000   DropPmt  0.9417
0.06383
DropPmt  7, 673.79
We can use the BA II Plus calculator to answer this question:
84,000 [] 0.94 [yx] 3 [=] [+/-] [PV]
0.06 [] 0.94 [] 100 [=] [I/Y] 10,000 [PMT]
[CPT] [N]
Result is 16.7618.
16 [N] [CPT] [FV] [] 0.94 [=]
Answer is 7,673.79.
Solution 11.19
D Section 11.03, Drop Payments
0.09
 0.0075
12
The level payments satisfy the following time-0 equation of value:
400, 000  Pmt  a240 0.0075
400, 000  Pmt  111.1450
Pmt  3,598.9038
When we subtract the present value of the extra payments, the new equation of value is:
400, 000  15, 000  a  3,598.9038  an 0.0075
4 1.007512 1
400, 000  15, 000  a4 0.09381  3,598.9038  an 0.0075
1  1.0075n
400, 000  15, 000  3.2128  3,598.9038 
0.0075
1  1.0075n
97.7541 
0.0075
0.2668  1.0075n
n  176.8050
The final payment therefore occurs after 177 months, which is 14.75 years:
177
 14.75
12
The loan originated on January 1, 2018, and the final payment is made 14 years and 9
months later. Adding 14 years to January 1, 2018 brings us to January 1, 2032. Adding

9 more months brings us to October 1, 2032. The payments are made at the end of each
month though, so the drop payment is made on September 30, 2032.
400,000 [PV] 240 [N] 0.75 [I/Y] [CPT] [PMT]
Result is 3,598.9038.
[STO] 1
4 [N] 1.0075 [yx] 12 [] 1 [=] [] 100 [=] [I/Y] 15,000 [PMT] [CPT] [PV]
[+] 400,000 [=]
Result is 351,807.5102.
[PV] 0.75 [I/Y] [RCL] 1 [PMT] [CPT] [N]
Result is 176.8050, so the final payment occurs after 177 months.
177 [] 12 [=]
Result is 14.75.
[+] 2018 [=]
Result is 2032.75.
The date of 2032.75 is 9 months after the beginning of 2032, so the drop payment is
made on September 30, 2032.
Solution 11.20
C Section 11.03, Balloon Payments
1.071/12  1  0.005654
L0 200, 000 200, 000
Pmt     1, 301.8493
a3012 0.005654 11.005654360 153.6276
0.0055654
There are 84 months in 12 years. The balloon payment is the amount of the loan
remaining at the end 83 months, accumulated to the end of the 84th month:
FinalPmt  L83  (1.005654)
 200, 000  (1.005654)83  1, 301.8493s83 0.005654  (1.005654)
 
 319,350.6403  1, 301.8493  105.5426  (1.005654)  182, 978.8574
We can also find this value using the BA II Plus calculator:

360 [N] 1.07 [yx] 12 [1/x] [] 1 [=] [] 100 [=] [I/Y] 200,000 [+/-] [PV]
[CPT] [PMT]
83 [N] [CPT] [FV]  1.07 [yx] 12 [1/x] [=]
Answer is 182,978.8574.
Solution 11.21
B Section 11.03, Balloon Payments
L0 100, 000 100, 000
Pmt   10
  12, 329.0944
a10 0.04 11.04 8.1109
0.04

After the second payment, the outstanding balance is:

L2  12,329.0944a8 0.04  12, 329.0944  6.7327  83, 008.6474
Using the new interest rate of 6%, the balloon payment is the amount of the loan
remaining at the end 9 years, accumulated to the end of the 10th year:
FinalPmt  L9  (1.06)
  L2  (1.06)9 2  12, 329.0944s9 2 0.06   1.06
 
 83, 008.6474  (1.06)  12, 329.0944s7 0.06   1.06
7
 
 124, 814.3139  12, 329.0944  8.3938  1.06
 21, 325.8969  1.06  22, 605.4507
10 [N] 4 [I/Y] 100,000 [+/-] [PV] [CPT] [PMT]
2 [N] [CPT] [FV] [+/-] [PV]
7 [N] 6 [I/Y] [CPT] [FV]  1.06 [=]
Answer is 22,605.4507.
Solution 11.22
B Section 11.03, Balloon Payments
Let’s use time-3 equation of value because at the end of 3 years, the first payment of
1,000 will occur 1 year later:
12, 000  1.053  1, 000an 0.05
13, 891.50  1, 000an 0.05
We use the BA II Plus calculator to find n:

13,891.50 [PV] 1,000 [+/-] [PMT] 6 [I/Y] [CPT] [N]
Result is 24.3092
Since we have n = 24.3092, we know that a 24th payment of 1,000 would not be sufficient
to pay off the loan. Therefore, the 24th payment must be the balloon payment. The
amount of this balloon payment is determined by finding the outstanding balance after the
23rd payment and then accumulating that balance for one more year. Below, we use L23
to indicate the balance after the 23rd payment has been made:
FinalPmt  L23  (1.05)
 
  12, 000  1.053  1.0523  1000s23 0.05   1.05
 
 13, 891.50  1.0523  1000  41.4305  1.05
 
 42, 668.0723  41, 430.4751  1.05
 1, 237.5971  1.05  1, 299.4770

12,000 [] 1.05 [yx] 3 [=] [+/-] [PV] 1,000 [PMT] 5 [I/Y] [CPT] [N]
Result is 24.3092
23 [N] [CPT] [FV]  1.05 [=]
Answer is 1,299.4770.

Chapter 12: Project Evaluation
Solution 12.01
A Section 12.01, Net Present Value
The net present value of the cash flows is:
2, 000 4, 000
NPV0  PV0 (Cash Flows)  5, 000    176.56
1.10 1.103
Since the net present value is negative, perhaps it wasn’t such a good idea for Ralph to
lend to Annie!
Solution 12.02
E Section 12.01, Net Present Value
The net present value of the cash flows is:
2,500 1, 000 2, 000
NPV0  PV0 (Cash Flows)  3, 000     49.1410
2 3
1.05 1.05 1.054
Solution 12.03
B Section 12.01, Net Present Value
The 70,000 received at the end of 3 years earns 3% for 2 years, and the 70,000 received
at the end of 4 years earns 3% for 1 year. The net present value is:
70, 000(1.03)2  70, 000  1.03
NPV   100, 000  4, 354.80
1.075
Solution 12.04
D Section 12.01, Net Present Value
The net present value of Project A is:
2, 000 5, 000
NPV0  PV0 (Cash Inflows)  PV0 (Cash Outflows)  5, 000  
1.08 1.082
 1,138.5460
We can set this equal to the net present value of Project B:
5, 000 X
1,138.5460  2, 000  
1.08 1.082
X  6, 404.80
Solution 12.05
B Section 12.01, Net Present Value
2
 0.07 
1    1  7.1225%
 2 

Chapter 12: Project Evaluation Solutions to End of Chapter Questions
Investment X has the greatest NPV because its cash flows are greater than or equal to the
cash flows of Investments Y and Z in each year. The net present value of Investment X is:
NPV0  PV0 (Cash Flows)
100 250 50 300 300 600
 1, 000      
2 3 4 5
1.071225 1.071225 1.071225 1.071225 1.071225 1.0712256
 108.11
Alternatively, we can use the cash flow worksheet in the BA II Plus calculator to find the
net present value. Below, we enter the amount of each cash flow and its corresponding
frequency. The initial cash flow is assumed to have a frequency of 1, so we don’t enter a
frequency for the initial cash flow:
[CF] CF0 = 1,000 [+/-] [ENTER] ↓
C01 = 100 [ENTER] ↓ ↓
C02 = 250 [ENTER] ↓ ↓
C03 = 50 [+/-] [ENTER] ↓ ↓
C04 = 300 [ENTER] ↓ 2 ↓
C05 = 600 [ENTER]
[NPV] 7.1225 [ENTER] ↓ [CPT]
The result is 108.10568.
The answer is 108.11.
Solution 12.06
C Section 12.02, Internal Rate of Return
The time-0 equation of value to be solved is:
368.15  100  100v  200v 2
0  200v 2  100v  268.15
We can use the quadratic formula to find v:
100  1002  4  200  268.15

v 
2  200
v  1.4346 or v  0.9346
We discard the negative value of v, and use the positive value to find i:
v  0.9346
1
 0.9346
1 i
i  0.07
Alternatively, the following equation, which is a re-ordered version of an equation found
above, shows us the values to put into the cash flow worksheet of the BA-II Plus
calculator:
0  268.15  100v  200v 2
We can now use the calculator to find the internal rate of return:
[CF] CF0 = 268.15 [+/-] [ENTER] ↓
C01 = 100 [ENTER] ↓ ↓
C02 = 200 [ENTER]
[IRR] [CPT]
The answer is 7.00%.

Solution 12.07
B Section 12.02, Internal Rate of Return
The time-0 equation of value to be solved is:
1, 000  1, 400v  3, 000v 2
1, 000  1, 400v  3, 000v 2  0
The easiest way to obtain the annual effective interest rate that satisfies the equation
above is to use the BA-II Plus calculator:
[CF] CF0 = 1,000 [ENTER] ↓
C01 = 1,400 [ENTER] ↓ ↓
C02 = 3,000 [+/-] [ENTER]
[IRR] [CPT]
The result is 16.8154%, which is an annual effective interest rate. We must convert it
into an interest rate that is convertible semiannually.
[] 100 [+] 1 [=] [yx] 0.5 [] 1 [=] [] 2 [=]
Answer is 0.1616.
Solution 12.08
A Section 12.02, Internal Rate of Return
The present value of the deposits is equal to the present value of the withdrawals. Let’s
use v to denote the 3-month discount factor:
1, 000  1, 200v  300v 2  600v 3  1, 400v 4
1, 000  1, 200v  300v 2  600v 3  1, 400v 4  0
[CF] CF0 = 1,000 [ENTER] ↓
C01 = 1,200 [ENTER] ↓ ↓
C02 = 300 [+/-] [ENTER] ↓ ↓
C03 = 600 [+/-] [ENTER] ↓ ↓
C04 = 1,400 [+/-] [ENTER]
[IRR] [CPT]
The result is 1.5283%, which is a quarterly effective interest rate. We must convert it
into an annual effective interest rate.
[] 100 [+] 1 [=] [yx] 4 [] 1 [=]
Answer is 0.0625.
Solution 12.09
D Section 12.02, Internal Rate of Return
Investment X has the greatest IRR because its cash flows are greater than or equal to the
cash flows of Investments Y and Z in each year. The IRR Investment X is the value of i
that sets the present value of the cash flows equal to 0:
PV0 (Cash Flows)  0
100 250 50 300 300 600
1, 000       0
2 3 4 5
(1  i ) (1  i ) (1  i ) (1  i ) (1  i ) (1  i )6

Alternatively, we can use the cash flow worksheet in the BA II Plus calculator to find the
internal rate of return. Below, we enter the amount of each cash flow and its
corresponding frequency. The initial cash flow is assumed to have a frequency of 1, so we
don’t enter a frequency for the initial cash flow:
[CF] CF0 = 1,000 [+/-] [ENTER] ↓
C01 = 100 [ENTER] ↓ ↓
C02 = 250 [ENTER] ↓ ↓
C03 = 50 [+/-] [ENTER] ↓ ↓
C04 = 300 [ENTER] ↓ 2 ↓
C05 = 600 [ENTER]
[IRR] [CPT]
The result is 9.7337.
The answer is 9.7337%.
Solution 12.10
E Section 12.02, Internal Rate of Return
The internal rate of return of Project A is determined by solving the following time-0
equation of value:
2, 000 5, 000
6, 000  
1 X (1  X )2
2, 000 5, 000
0  6, 000  
1 X (1  X )2
[CF] CF0 = 6,000 [+/-] [ENTER] ↓
C01 = 2,000 [ENTER] ↓ ↓
C02 = 5,000 [ENTER]
[IRR] [CPT]
The result is 9.4627%, which is an annual effective interest rate. Let’s store this rate so
that it is available when we calculate the NPV of Project B:
[STO] 1
We clear the cash flow worksheet and then use it to find the NPV of Project B:
[CF] [2nd] [CLR WORK]
CF0 = 1,000 [+/-] [ENTER] ↓
C01 = 0 [ENTER] ↓ ↓
C02 = 3,000 [+/-] [ENTER] ↓ ↓
C03 = 5,000 [ENTER]
[NPV] [RCL] 1 [ENTER] ↓ [CPT]
The answer is 308.42.

Chapter 13: Fixed Income Securities
Solution 13.01
C Section 13.01, Pricing Noncallable Bonds
The formula for the price of the bond can be used to find the redemption value:
P  Coup  an y  Rv n
R
129.24  3.5  a20 0.02 
1.0220
R
129.24  3.5  16.3514 
1.0220
R  107.00
20 [N] 2 [I/Y] 129.24 [+/-] [PV] 3.5 [PMT]
[CPT] [FV]
Answer is 107.00.
Solution 13.02
D Section 13.01, Pricing Noncallable Bonds
We can use the BA II Plus to obtain the quarterly effective yield. We multiply by 4 to
obtain the nominal yield convertible quarterly:
100 [N] 925 [+/-] [PV] 1,000 [] 0.10 [] 4 [=] [PMT] 1,000 [FV]
[CPT] [I/Y]
Result is 2.7189.
[] 4 [=]
Answer is 10.88%.
Solution 13.03
B Section 13.01, Pricing Noncallable Bonds
The 6-month effective yield is:
1
 1, 000  24
y    1  0.02469
 556.84 
The price of the bond is:
1, 000
P  Coup  an y  Rv n  25  a30 0.02469 
1.0246930
1  1.0246930
 25   481.0199  25  21.0157  481.0199  1, 006.41
0.02469
1,000 [] 556.84 [=] [yx] 24 [1/x] [=] [] 1 [=] [] 100 [=] [I/Y]
30 [N] 25 [PMT] 1,000 [FV]
[CPT] [PV]

Chapter 13: Fixed Income Securities Solutions to End of Chapter Questions
Solution 13.04
1,150
P  Coup  an y  Rv n  40  a60 0.045   40  20.6380  81.9824
1.04560
 907.50
60 [N] 4.5 [I/Y] 40 [PMT] 1,150 [FV] [CPT] [PV]
Solution 13.05
E Section 13.01, Pricing Noncallable Bonds
1  v 2n
P  Coup  a2n i  Rv 2n  1, 000r   543
i
 1, 000  1.25(1  v 2n )  543  1, 250(1  0.70262 )  543
 1,175.94
Solution 13.06
A Section 13.01, Pricing Noncallable Bonds
The redemption value of the bond is found below:
P  Coup  a2n i  Rv 2n
1  v 2n
1, 225  1, 000r   Rv 2n
i
1, 225  1, 000  1.25(1  0.70262 )  R  0.70262
R  1,199.36
Solution 13.07
C Section 13.01, Pricing Noncallable Bonds
The equation of value that equates the prices of the two bonds is:
1,100 912
30  a40 0.03   30  a40 i/2 
1  2i 
40 40
1.03
The easiest way to find i is to use the BA II Plus calculator:

40 [N] 3 [I/Y] 30 [PMT] 1,100 [FV] [CPT] [PV]
Result is 1,030.6557.
912 [FV] [CPT] [I/Y] [] 2 [=]

Solution 13.08
E Section 13.01, Pricing Noncallable Bonds
The equation of value that equates the prices of the two bonds is:
1.1X 0.895 X
0.03 X  a40 0.03   0.03 X  a40 i/2 
1  2i 
40 40
1.03
1.1 0.895
0.03  a40 0.03   0.03  a40 i/2 
1  2i 
40 40
1.03
The easiest way to find i is to use the BA II Plus calculator:

40 [N] 3 [I/Y] 0.03 [PMT] 1.1 [FV] [CPT] [PV]
0.895 [FV] [CPT] [I/Y] [] 2 [=]
Solution 13.09
The equation of value can be solved for R:
P  Coup  an y  Rv n
0.0495 R
100, 000  R  a 
40 1.050.5 1
2 1.0520
 1  1.0520 1 
100, 000  R 0.02475   
 1.050.5  1 1.0520 
 1 
100, 000  R 0.02475  25.2322  
 1.0520 
R  99, 861.61
1.05 [yx] 0.5 [] 1 [=] [] 100 [=] [I/Y]
40 [N] 0.0495 [] 2 [=] [PMT] 1 [FV] [CPT] [PV]
[1/x] [] 100,000 [=]
Solution 13.10
B Section 13.01, Noncallable Bonds
The bond price is:
1, 000
P  Coup  an y  Rv n  35  a20 0.025 
1.02520
1  1.02520
 35   610.2709  35  15.5892  610.2709  1,155.8916
0.025
Since the investor borrows the purchase price of the bond at an annual effective rate of
4%, the amount to be repaid at the end of 10 years is:
1,155.8916  1.0410  1, 711.0020

The proceeds from the invested coupons and the redemption value of the bond at time 10
years is:
1.01520  1
Coup  sn  R  35s20 0.015  1, 000  35   1, 000
0.015
 35  23.1237  1, 000  1, 809.3283
The net cash flow at the end of 10 years is equal to her net gain:
1, 809.3283  1, 711.0020  98.33
20 [N] 2.5 [I/Y] 35 [PMT] 1,000 [FV]
[CPT] [PV] [] 1.04 [yx] 10 [=] [STO] 1
(Result is 1,711.0020)
1.5 [I/Y] 0 [PV] [CPT] [FV] [] 1,000 [=] [+/-]
(Result is 1,809.3283)
[+] [RCL] 1 [=]
Answer is 98.33.
Solution 13.11
The semiannual coupon rate of Bond X is

 i  0.02 and the semiannual coupon rate of
2
Bond Y is
 i  0.02 .
2
The price of Bond X exceeds the price of Bond Y by 2,816.93:
 
i  10, 000  i  10, 000 
10, 000   0.01  a20 i /2   10, 000   0.01  a20 i /2 
2
   
2
2  1  2i  2  1  2i 
 
 2, 816.93
10, 000  0.02  a20 i /2  2, 816.93

2,816.93 [] 10,000 [] 0.02 [=] [PV]
20 [N] 1 [+/-] [PMT] [CPT] [I/Y]
[] 2 [=]
Solution 13.12
B Section 13.01, Noncallable Bonds
At the end of each month, the net cash flow to Steve is the coupon payment from the
bond minus the interest on the loan:
0.10 0.08
10, 000   3, 000   63.3333
12 12
At the end of 10 years, Steve receives 10,000 from the bond and pays back the 3,000
loan, giving him a net cash flow of:
10, 000  3, 000  7, 000

Since the cost of entering this position is 7,000, the time-0 equation of value is:
7, 000
7, 000  63.3333  a (12) 
180 i 180
12 1  i(12) 
 12 

180 [N] 7,000 [+/-] [PV]
10,000 [] 0.10 [] 12 [] 3,000 [] 0.08 [] 12 [=] [PMT]
7,000 [FV] [CPT] [I/Y]
Result is 0.9048.
[] 100 [+] 1 [=] [yx] 12 [] 1 [=]
Answer is 0.1141.
Solution 13.13
C Section 13.01, Noncallable Bonds
The time-0 equation of value can be used to solve for c:
  1.03 
2
 1.03  
14
300 1.03
708.11  c     
1.057  1.05  1.05   1.05  

15
1.03  1.03 
 
1.05  1.05 
494.9056  c 
1.03
1
1.05
c  34.00
Solution 13.14
E Section 13.01, Noncallable Bonds
Since the yield is equal to the coupon rate, the price of the bond is 1,000. Since the
investment in the bond results in a yield of 9%, we have the following equation of value:
1, 000(1.09)12  40s  1, 000
24 (1 i )0.5 1
We can use the BA-II Plus calculator to answer this question:

1,000 [] 1.09 [yx] 12 [] 1,000 [=] [FV]
24 [N] 40 [+/-] [PMT] [CPT] [I/Y]
Result is 5.1380.
[] 100 [+] 1 [=] [x2] [] 1 [=]
Solution is 0.1054.
Solution 13.15
The first equation of value below sets the value of the first bond equal to the value of the
second bond, and the second equation sets the value of the second bond equal to the
value of the third bond:
0.0517  1, 200  an  1, 200v n  0.0648  1, 050  an  1, 050v n
0.0648  1, 050  an  1, 050v n  950r  an  950v n

The two equations above can be simplified as follows:

150v n  6  an
100v n  (950r  68.04)  an
Dividing the first equation into the second equation allows us to solve for r:
150v n 6  an

100v n (950r  68.04)  an
150 6

100 (950r  68.04)
950r  68.04  4
r  0.0758
Solution 13.16
E Section 13.02, Noncallable Bonds
At the end of 15 years, the accumulated value of the proceeds from the bond is:
AV15  35s30 0.025  1, 000  35  43.9027  1, 000  2,536.5946
The 6-month effective yield, y, equates the present value of the proceeds with the
purchase price:
2,536.5946
1, 245 
(1  y )30
y  0.02401
The nominal yield convertible semiannually is twice the 6-month effective yield:
2y  2  0.02401  0.0480
30 [N] 2.5 [I/Y] 35 [PMT] [CPT] [FV]
Result is 1,536.5946.
[] 1,000 [=] [FV] 0 [PMT] 1,245 [PV] [CPT] [I/Y]
Result is 2.4007
[] 2 [=]
Answer is 4.80%.
Solution 13.17
B Section 13.02, Bond Investment Income
The book value at the end of 7 years is the present value of the bond’s cash flow over the
remaining 8 years:
1, 000
BV7  0.06  1, 000  a8 0.04   60  6.7327  730.6902
1.048
 1,134.6549
The interest (which is also known as the investment income) portion of the 8th payment
is:
InvInc8  BV7  y  1,134.6549  0.04  45.39
8 [N] 4 [I/Y] 0.06 [] 1,000 [=] [PMT] 1,000 [FV]

[CPT] [PV]
Result is 1,134.6549.
[] 0.04 [=]
Solution 13.18
A Section 13.02, Book Values
The discount accrued with the 7th coupon is 11:
BVt  BVt 1  DAt
BV7  BV6  DA7
DA7  BV7  BV6
DA7  11
The discount accrued can also be written as:
DAt  (Ry  Coup)v n  t 1
We can now solve for n:
11  (3, 000  0.035  3, 000  0.03)v n 7 1
0.7333  1.0356  n
6  n  9.0158
n  15.0158
The n that was found above is the number of coupons paid, but the question asks for the
number of years until the bond matures. Therefore, we must divide the n above by 2:
15.0158
 7.51
2
Solution 13.19
D Section 13.02, Book Values
The rate of growth of the accumulation of discount is equal to the yield:
DAt  k
 (1  y )k
DAt
841.68
 (1  y )29 12
194.49
y  0.09000
We use the discount accumulated in the 12th coupon to find the difference between the
yield times the redemption value and the coupon:
DAt  (Ry  Coup)v n  t 1
Ry  Coup
194.49 
1.0900030 12 1
Ry  Coup  999.9998
The discount at the time of purchase is:
Discount  (Ry  Coup)an y  999.9998  a30 0.09000
 999.9998  10.2737  10, 273.66

Solution 13.20
C Section 13.02, Book Values
We can use the book values provided to find the coupon amount:
BVt  k  BVt (1  y )k  Coup  sk y
BV15  BV14 (1.05)  Coup  s1 0.05
2,223.33  2, 254.60(1.05)  Coup  1
Coup  144.00
We can now use the prospective formula to find n:
BVt  Coup  an  t y  Rv n  t
BV14  144  an 14 0.05  2, 000v n 14
1  1.05(n 14)
2,254.60  144   2, 000v n 14
0.05
 
2,254.60  2, 880 1  v n 14  2, 000v n 14
625.40  880v n 14

0.7107  1.0514  n
14  n  7.0000
n  21.00
2,254.60 [] 1.05 [] 2,223.33 [=]
Result is 144.
[PMT] 5 [I/Y] 2,254.60 [+/-] [PV] 2,000 [FV]
[CPT] [N]
Result is 7.0000.
[+] 14 [=]
Answer is 21.00.
Solution 13.21
A Section 13.03, Callable Bonds
The present value of the coupons and the redemption value is equal to the purchase price:
0.08 1,150
988   1, 000a2n 0.045 
2 1.0452n
We can use the BA II Plus to obtain 2n, the number of 6-month periods that the bond was
held. We then divide by 2 to obtain the number of years that the bond was held:
4.5 [I/Y] 988 [+/-] [PV] 40 [PMT] 1,150 [FV]
[CPT] [N]
Result is 22.0076.
[] 2 [=]
Answer is 11.00.

Solution 13.22
D Section 13.03, Callable Bonds
Since this bond is a discount bond, its price-to-worst is found by assuming that the bond
is held until maturity. Therefore, the highest price that the investor can pay and be
assured of the desired yield is 803.64.
The bond is called after 15 years for 1,030, and therefore the time-0 equation of value is:
1, 030
803.64  60  a15 
(1  y )15
The BA-II Plus can be used to find the yield that satisfies the equation of value:
15 [N] 803.64 [+/-] [PV] 60 [PMT] 1,030 [FV]
[CPT] [I/Y]
Result is 8.4663.
Answer is 8.47%.
Solution 13.23
B Section 13.03, Callable Bonds
The bond is a discount bond, because the coupon is less than the yield-to-worst times the
redemption value:
0.045  1, 000  0.05  1, 000  Coup  YTW  Rt
k
Since the bond is a discount bond, its price-to-worst is calculated based on the latest
possible redemption:
P  45  a24 0.05  1, 000v 24  45  13.7986  310.0679  931.01

24 [N] 5 [I/Y] 45 [PMT] 1,000 [FV] [CPT] [PV]
Solution 13.24
C Section 13.03, Callable Bonds
The coupon is greater than the product of the yield-to-worst and the final redemption
value, so the bond is a premium bond:
0.035  X  0.025  X  Coup  YTW  Rt
k
Since the bond is a premium bond, the yield-to-worst can be found by identifying each
interval defined by level redemption prices and considering the possibility that the bond is
called at the beginning of each interval. In this case, there is only one such interval, and
it runs from time 10 years until maturity. The yield-to-worst is based on the beginning of
the interval, which occurs at time 10 years. The equation of value is:
X
1, 733.84  0.035 Xa20 0.025 
1.02520
20 [N] 2.5 [I/Y] 0.035 [PMT] 1 [FV]
[CPT] [PV]
[1/x] [] 1,733.84 [=]

Solution 13.25
D Section 13.03, Callable Bonds
We observe that the coupon of 50 is greater than the yield-to-worst times the final
redemption value:
YTW  R  0.03  1, 200  36
Therefore, the bond is a premium bond, and the earliest possible redemption within each
interval of level redemption prices should be considered. The price-to-worst is the
minimum of the two resulting prices:
 1,300 1,200 
Min 50  a20 0.03  , 50  a30 0.03  
 1.0320 1.0330 
20 [N] 3 [I/Y] 50 [PMT] 1,300 [FV]
[CPT] [PV]
Result is 1,463.6522.
[STO] 1
30 [N] 1,200 [FV] [CPT] [PV]
Result is 1,474.4062.
Since 1,463.6522 is less than 1,474.4062, the price-to-worst is 1,463.65.
Solution 13.26
B Section 13.03, Callable Bonds
We observe that the coupon of 50 is greater than the yield-to-worst times the final
redemption value:
YTW  R  0.03  1, 200  36
Therefore, the bond is a premium bond, and the earliest possible redemption within each
interval of level redemption prices should be considered. The price-to-worst is the
minimum of the two resulting prices:
 1, 400 1,200 
Min 50  a20 0.03  , 50  a30 0.03  
20
 1.03 1.0330 
20 [N] 3 [I/Y] 50 [PMT] 1,400 [FV]
[CPT] [PV]
Result is 1,519.0198.
[STO] 1
30 [N] 1,200 [FV] [CPT] [PV]
Result is 1,474.4062.
Since 1,474.4062 is less than 1,519.0198, the price-to-worst is 1,474.41.
Solution 13.27
C Section 13.03, Callable Bonds
The coupon is less than the product of the yield-to-worst and the final redemption value,
so the bond is a discount bond:
0.015  X  0.02  X  Coup  YTW  Rt
k

Therefore, the yield-to-worst is based on the latest possible redemption, which occurs at
the end of 20 years. The equation of value is:
X
1,104.92  0.015 Xa40 0.02 
1.0240
40 [N] 2 [I/Y] 0.015 [PMT] 1 [FV]
[CPT] [PV]
[1/x] [] 1,104.92 [=]
Solution 13.28
E Section 13.03, Callable Bonds
Since the price is less than the redemption value of 1,200, the bond is a discount bond.
Therefore, the yield-to-worst is based on the latest possible redemption, which occurs at
the end of 15 years. The equation of value is:
1, 200
1,150  (0.025  1,200)a30 y 
(1  y )30
30 [N] 1150 [+/-] [PV] 0.025 [] 1,200 [=] [PMT] 1,200 [FV]
[CPT] [I/Y]
Result is 2.7045.
[] 2 [=]
Answer is 5.4091%.

Chapter 14: Duration and Convexity
Solution 14.01
D Section 14.01, Macaulay Duration
Since the bond is priced at par, its Macaulay duration is:
18
MacD  a (2)  1  1.0325
(m)  a  1.0325  6.95
n 9 0.065
Solution 14.02
A Section 14.01, Portfolio Duration
The duration of a portfolio is the weighted average duration of its components:
k
100  8  75.50  13  60.41  12
MacDPort   w j  MacD j 
100  75.50  60.41
j 1
2,506.42
  10.62
235.91
Solution 14.03
E Section 14.01, Macaulay Duration
The easiest way to approach this question is to keep in mind that the Macaulay duration is
the weighted average of the times that the cash flows occur.
The formula for Macaulay Duration is:
 t  PV0 CFt 

t 0
MacD 
 PV0 CFt 
t 0
The expression above illustrates that the Macaulay duration is the weighted average of the
times that the cash flows occur.
After 6 months, the bond’s cash flows are still the same cash flows as before, but they
now occur 6 months earlier. The weights are unchanged, because both the numerator
and the denominator of each weight is multiplied by (1.08)0.5 . Therefore, the weighted
average of the times that the cash flows occur is 0.5 less than the original weighted
average:
X  Y  0.50
Alternatively, we can calculate the Macaulay duration of the 3-year bond and the 2.5-year
bond separately and then find the difference.
The price and the duration of the 3-year bond are found below:
6 6 106
P3  year   PV0 CFt   1.08  1.082  1.083  94.8458
t 0
 t  PV0 CFt  6 6 106

t 0 1.081 1.082 1.083
X   1 2  3
 PV0 CFt  94.8458 94.8458 94.8458
t 0
 1  0.0586  2  0.0542  3  0.8872  2.8286

Chapter 14: Duration and Convexity Solutions to End of Chapter Questions
The price and the duration of the 2.5-year bond are found below:
6 6 106
P2.5  year   PV0 CFt   1.080.5  1.081.5  1.082.5  98.5667
t 0
 t  PV0 CFt  6 6 106

t 0 1.080.5 1.081.5 1.082.5
Y   0.5   1.5   2.5 
 PV0 CFt  98.5667 98.5667 98.5667
t 0
 0.5  0.0586  1.5  0.0542  2.5  0.8872  2.3286
The times used to calculate Y are 0.5 less than the times used to calculate X, but the
weights of 0.0586, 0.0542, and 0.8872 have not changed.
The difference is:
X  Y  2.8286  2.3286  0.50
Solution 14.04
C Section 14.01, Macaulay Duration
 t  PV0 CFt 

t 0
MacD 
 PV0 CFt 
t 0
After 6 months, the bond’s cash flows are still the same cash flows as before, but they
now occur 6 months earlier. The weights are unchanged, because both the numerator
and the denominator of each weight is multiplied by (1  y )0.5 . Therefore, the weighted
average of the times that the cash flows occur is 0.5 less than the original weighted
average:
9.8  0.5  9.3
Solution 14.05
The easiest way to approach this question is to keep in mind that the Macaulay duration is
the weighted average of the times that the cash flows occur, and each of the cash flows is
moved back by one year when we go from an annuity-due to an annuity-immediate.
 t  PV0 CFt 

t 0
MacD 
 PV0 CFt 
t 0
When we go from an annuity-due to an annuity immediate, the cash flows are unchanged,
but each cash flow occurs one year later. The weights have not changed, because both
the numerator and the denominator of each weight is multiplied by v. Therefore, the
weighted average of the times that the cash flows occur is just one year more than the
weighted average for the annuity-due:
31  4

Alternatively, let’s use Pmt A to indicate the level payment of the annuity-due and PmtB
to indicate the level payment of the annuity-immediate.
The Macaulay duration of the annuity-due is:
3

Pmt A 0  v  2v 2    (n  1)v n 1 

Pmt A 1  v  v    v 2 n 1

v  2v 2    (n  1)v n 1
3
1  v  v 2    v n 1
The Macaulay duration of the second annuity is:
MacDB 

PmtB v  2v 2    nv n   v  2v 2
   nv n

PmtB v  v 2    v n  v  v2    v n
1  2v    nv n 1 (1  v    v n 1 )  v  2v 2    (n  1)v n 1
 
1  v    v n 1 1  v    v n 1
1  v    v n 1 v  2v 2    (n  1)v n 1
  13  4
1  v    v n 1 1  v    v n 1
Solution 14.06
80 80 1, 080
 PV0 CFt   1.15  1.152  1.153  840.1742
t 0
The numerator of the formula for the Macaulay duration is:
80  1 80  2 1, 080  3
 t  PV0 CFt   1.15

1.152

1.153
 2, 320.9008
t 0
The Macaulay duration is:
 t  PV0 CFt  2,320.9008

t 0
MacD    2.7624
 PV0 CFt  840.1742
t 0
Solution 14.07
Since the cash flows appear in both the numerator and the denominator of the formula for
Macaulay duration, we can factor out the factor of 1,000 when using the cash flows in the
formula. That is, 50,000 can be written as 50 in both the numerator and denominator
below.
 t  PV0 CFt  5022  3533  12044 557.3646

t 0
MacD   1.06 1.06 1.06
  3.30
 PV0 CFt  50
1.062
 35
1.063
 1204
1.06
168.9377
t 0

Solution 14.08
 t  PV0 CFt  10v  20v 2    60v 6  70v 7  700v 7

t 0
MacD  
 PV0 CFt  10v  10v 2    10v 7  100v 7
t 0
10(Ia)7 0.07 
700 5.7665  7v 7
7 10   435.9248
 1.07  0.07
100 10  5.3893  62.2750
10a7 0.07 
1.077
10  20.1042  435.9248 636.9665
   5.4832
53.8929  62.2750 116.1679
Alternatively, we can use the BA II Plus cash flow worksheet to answer this question:
7 [N] 7 [I/Y] 10 [PMT] 100 [FV]
[CPT] [PV]
(Result is 116.1679)
[CF] 0 [ENTER] ↓
10 [ENTER] ↓↓
20 [ENTER] ↓↓
30 [ENTER] ↓↓
40 [ENTER] ↓↓
50 [ENTER] ↓↓
60 [ENTER] ↓↓
770 [ENTER]
[NPV] 7 [ENTER] ↓ [CPT]
[] [RCL] [PV] [=]
(Result is 5.4832)
Answer is 5.4832.
Solution 14.09
B Section 14.01, Macaulay Duration
After the first coupon is paid, the bond is still priced at par, so the remaining 8-year bond
has a price of 6,000.
The amount of each coupon payment is:
6, 000  0.04  240
The duration of an immediate payment of 240 is 0, and the duration of the 8-year bond is
DA . A portfolio consisting of an immediate payment of 240 and the 8-year bond has a
duration of DB .
k
240 6, 000
DB  MacDPort   w j  MacD j 
240  6, 000
0
240  6, 000
 DA
j 1
 0.9615  DA

The ratio is:

DB 0.9615  DA
  0.9615
DA DA
Alternatively, we can make use of the fact that the bond is priced at par. At the outset,
the Macaulay duration of the 9-year bond is a . As shown below, we can also write the
9
Macaulay duration as the weighted average of the timing of the cash flows:
9
 t  240  v t   9  6, 000  v 9
MacD at outset  t 1 
a
9 9
 240  v t   9  6, 000  v 9
t 1
One year later, just before the first coupon is paid, the weighted average of the timing of
the cash flows is one year less:
9
 (t  1)  240  v t 1   (9  1)  6, 000  v 91
DB  t 1
9
 240  v t 1   9  6, 000  v 91
t 1
9
 (t  1)  240  v t   (9  1)  6, 000  v 9
 t 1   1
a
9 9
 240  v t   9  6, 000  v 9
t 1
After the first coupon is paid, there are 8 coupon payments remaining, so the duration of
the bond is then:
DA  a
8
The ratio is:
DB a  1 a a8
 9  8   0.9615
DA 
a8 
a8 1.04  a8
Solution 14.10
After the 3rd coupon is paid, the bond is still priced at par, so the remaining (n  3)-year
bond has a price of par.
Let F be the par value of the bond. The amount of each coupon payment is:
0.04F
The duration of an immediate payment of 0.04F is 0, and the duration of the (n  3)-year
bond is DA . A portfolio consisting of an immediate payment of 0.04F and the (n  3)-
year bond has a duration of DB .
k
0.04F F
DB  MacDPort   w j  MacD j 
0.04F  F
0
0.04F  F
 DA
j 1
1
  DA
1.04

The ratio is:

1
DB  DA
 1.04  0.9615
DA DA
Alternatively, we can make use of the fact that the bond is priced at par. At the outset,
 .
the Macaulay duration of the n-year bond is a n
Immediately after the second coupon is paid, there are n  2 coupon payments remaining,

so the Macaulay duration of the bond is a . One year later, just before the 3rd coupon
n 2
is paid, the time until each cash flow is one year less, so the weighted average of the
times is one year less:

DB  a 1
n 2
Just after the third coupon is paid, there are n  3 coupon payments remaining, so the
duration of the bond is then:

DA  a n 3
The ratio is:
DB a  1 an 3 an 3
 n 2    0.9615
DA 
an 3 
an 3 1.04  an 3
Solution 14.11
 t  PV0 CFt 

t 0
MacD 
 PV0 CFt 
t 0
We can use the duration of the 3-year annuity to solve for v. Let’s use Pmt3 to indicate
the level payment of the 3-year annuity. We don’t need to know the amount of the level
payment, because it can be factored out of both the numerator and the denominator when
calculating duration:
0.96 

Pmt3 0  v  2v 2 

Pmt3 1  v  v 2 
0.96  0.96v  0.96v 2  v  2v 2
1.04v 2  0.04v  0.96  0
0.04  0.042  4(1.04)(0.96)

v 
2  1.04
v  0.9417 or v  0.9802
We use the positive discount factor to find the duration of Annuity B.

Once again, we do not need to know the amount of the level payment, because it can be
factored out of both the numerator and the denominator:

Pmt4 0  v  2v 2  3v 3   0.9417  2  0.9417
2
 3  0.94173

5.2210
 2
Pmt4 1  v  v  v 3
 2
1  0.9417  0.9417  0.9417 3 3.6638
 1.4250
Solution 14.12
The amount of each coupon payment is:
0.06  1, 000  60
After the 4th coupon is paid, the price of the bond is:
1, 000
P  60  a5 0.04   1, 089.0364
1.045
The duration of an immediate payment of 60 is 0, and the duration of the 5-year bond is
DA . A portfolio consisting of an immediate payment of 60 and the 5-year bond has a
duration of DB .
k
DB  MacDPort   w j  MacD j
j 1
60 1, 089.0364
 0  DA  0.9478  DA
60  1, 089.0364 60  1, 089.0364
The ratio is:
DB 0.9478  DA
  0.9478
DA DA
Solution 14.13
E Section 14.02, Modified Duration
Modified duration can be expressed in terms of the derivative of the bond’s price or in
terms of the Macaulay duration:
MacD
ModD 
y (m)
1
m

   MacD
P ' y (m)
P y  1 y
(m) (m)
m
1, 000 MacD
 
100 1  0.05
MacD  10.50

Solution 14.14
D Section 14.02, Modified Duration
The price of the stock and the derivative of its price are:
Div
P(y )   Div  y 1
y
P '(y )  Div  y 2
The modified duration is:
P ' y  Div  y 2 1 1
ModD       12.5
P y  Div  y 1 y 0.08

MacD  ModD  (1  y )  12.5  1.08  13.5
Solution 14.15
A Section 14.02, Modified Duration
Since the bond is priced at par, its yield is equal to its coupon rate.
MacD 6.88
ModD    6.4060
(m) 1.074
y
1
m
The estimated percentage change in the price is:
%P  ModD  y (m)  6.4060  (0.068  0.074)  0.03844
The estimate for the new price is:
100(1  %P )  100(1  0.03844)  103.84
Solution 14.16
E Section 14.02, Duration
The Macaulay duration of Bond A is:
 1  1.084
MacDA  a   1.08  3.5771
4 0.08
The modified duration of Bond A is:
MacDA 3.5771
ModDA    3.3121
(m) 1.08
y
1
m
The modified duration of Bond B is equal to the modified duration of Bond A:
ModDB  3.3121

The Macaulay duration of Bond B is found below:

MacDB
ModDB 
y (m)
1
m
MacDB
3.3121 
0.08
1
2
MacDB  3.3121  1.04
MacDB  3.4446
Solution 14.17
C Section 14.02, Modified Duration
The price of the stock and the derivative of its price are:
Div1
P(y )   Div1  (y  g)1
yg
P '(y )  Div1  (y  g)2
P ' y  Div1  (y  g)2 1 1 1
ModD      
P y  Div1  (y  g)1 y  g 0.04  0.01 0.03
 33.3333
MacD  ModD  (1  y )  33.3333  1.04  34.67
Solution 14.18
A Section 14.02, Modified Duration
The price and the derivative of the price can be used to obtain an expression for the
modified duration:
1
P 1
y
P '  y 2
P' y 2 1 1
ModD     
P  1 2 y(1  y )
1y y y
The relationship between the modified duration and the Macaulay duration can be used to
find the yield:
MacD
ModD 
1 y
1 28

y(1  y ) (1  y )
1
 28
y
1
y 
28


1 1
ModD    27.03
y(1  y ) 1
28 1  281 
Solution 14.19
D Section 14.02, Modified Duration
Modified duration can be expressed in terms of the derivative of the bond’s price or in
terms of the Macaulay duration:
ModD  
   MacD
P ' y (m)
P y  1 y
(m) (m)
m
1, 000 MacD
 
100 1  0.025
MacD  10.25
Since the bond is priced at par, its Macaulay duration is equal to the present value of an
annuity-due:
(2)
MacD  a
n
1  (1.025)2n
MacD   1.025
0.05
1  (1.025)2n
10.25   1.025
0.05
0.5  1.0252n
ln(0.5)
2n 
ln(1.025)
n  14.0355
1,000 [] 100 [] 1.025 [=]
Result is 10.25.
[+/-] [PV] 0.5 [PMT] 2.5 [I/Y]
[CPT] [N]
[] 2 [=]
Answer is 14.0355.
Solution 14.20
D Section 14.03, Modified Convexity
The estimated percentage change in price is:
 
2
%P  ModD  y (m)  0.5  ModC  y (m)
 11.904  (0.01)  0.5  197.238  (0.01)2

 0.1289

Solution 14.21
B Section 14.03, Modified Convexity
The estimated percentage change in price is:
 
2
%P  ModD  y (m)  0.5  ModC  y (m)
 11.904  (0.01)  0.5  197.238  (0.01)2

 0.1289
The estimate for the new price is:
X  885.30(1  %P )  885.30  1.1289  999.4169
If the yield decreases to 5%, then the yield will be equal to the coupon rate, and the bond
will be a par bond:
Y  1, 000
The difference is:
X  Y  999.4169  1, 000  0.5831
Solution 14.22
D Section 14.03, Macaulay Convexity
The dispersion of a zero-coupon bond is zero, so the Macaulay convexity of a zero-coupon
bond is equal to the square of its time until maturity:
MacC10  MacD2  Dispersion  102  0  100
The Macaulay convexity of the portfolio is the weighted average of the Macaulay
convexities of its components:
2
MacCPort   w j  MacC j  0.50  102  0.50  202  250
j 1
Solution 14.23
C Section 14.03, Macaulay Convexity
The Macaulay duration of a zero-coupon bond is equal to its time until maturity, so the
durations of the bonds are:
MacD10  10 MacD20  20
The two bonds have the same price, so their weights in Mike’s portfolio are equal:
895.42
P10   500.00
1.0610
1, 603.57
P20   500.00
1.0620
The Macaulay duration of the portfolio is the weighted average of the Macaulay durations
of its components:
2
500 500
MacDPort   w j  MacD j  500  500  10  500  500  20  0.50  10  0.50  20
j 1
 15

The Macaulay convexity of a zero-coupon bond is equal to the square of its time until
maturity, so the Macaulay convexities of the two bonds are:
The Macaulay convexity of the portfolio is the weighted average of the Macaulay
convexities of its components:
2
MacCPort   w j  MacC j  0.50  102  0.50  202  250
j 1
We can now find the modified convexity of the portfolio:

MacD 15
MacC  250 
ModC  m  1  235.85
2 2
 y ( m)  1.06
1  m 
 
Solution 14.24
E Section 14.03, Modified Convexity
The price of the stock and the derivatives of its price are:
Div
P(y )   Div  y 1
y
P '(y )  Div  y 2
P ''(y )  2  Div  y 3
The modified convexity is:
P ''  y  2  Div  y 3 2 2
ModC      312.50
P y  Div  y 1
y 2
0.082
Solution 14.25
C Section 14.03, Macaulay Convexity
The price of the stock and the derivatives of its price are:
Div
P(y )   Div  y 1
y
P '(y )  Div  y 2
P ''(y )  2  Div  y 3
The modified duration and convexity are:
P ' y  Div  y 2 1 1
ModD       12.5
P y  Div  y 1 y 0.08
P ''  y  2  Div  y 3 2 2
ModC      312.50
P y  Div  y 1
y 2
0.082
MacD  ModD  (1  y )  12.5  1.08  13.5

We can use the formula that expresses modified convexity in terms of Macaulay
convexity:
MacD
MacC 
ModC  m
2
 y(m) 
1  m 
 
13.5
MacC 
312.50  1
 
2
1 0.08
1
MacC  351
Solution 14.26
D Section 14.05, First-Order Macaulay Approximation
The first-order Macaulay approximation of the new price is:
MacD
 1 y 
P(y  y )  P(y )   
 1  y  y 
The approximate percentage change in price, using the first-order Macaulay
approximation, is:
MacD 14
P(y  y )  1 y   1  0.08 
1    1    1
P(y )  1  y  y   1  0.08  0.0040 
14
 1.0800 
   1  1.053321  1  0.053321
 1.0760 
Solution 14.27
C Section 14.05, First-Order Macaulay Approximation
MacD 8.776
 1 y   1.074 
P(y  y )  P(y )     1, 000     1, 033.29
 1  y   y   1.070 
Solution 14.28
A Section 14.05, First-Order Macaulay Approximation
The Macaulay duration is the modified duration multiplied by the one-period accumulation
factor:
MacD  ModD  (1  y )  9  1.074  9.666
MacD 9.666
 1y   1.074 
EMac  P(y )     850.46     805.874
 1  y   y   1.080 
The first-order modified approximation of the new price is:
EMod  P  y   1  ModD  y   850.46  1  9  0.006   804.535
The difference in the estimates is:

EMac  EMod  805.874  804.535  1.339

Solution 14.29
D Section 14.05, First-Order Macaulay Approximation
The Macaulay duration of the portfolio is the weighted average of the durations of Bond A
and Bond B:
5.4  70, 000  11.9  30, 000
MacD   5.4  0.70  11.9  0.30  7.35
70, 000  30, 000
The first-order Macaulay approximation of the new price is 96,000:
MacD
 1 y 
P(y  y )  P(y )   
 1  y   y 
7.35
 1.065 
96, 000  (70, 000  30, 000)   
 1i 
7.35
 1.065 
0.96   
 1 i 
1.065
0.961/7.35 
1 i
i  0.070931
Solution 14.30
B Section 14.05, First-Order Macaulay Approximation
The first-order Macaulay approximation of the new price can be used to solve for the
Macaulay Duration:
MacD
 1 y 
P(y  y )  P(y )   
 1  y   y 
MacD
 1.074 
57, 021.04  59,776.39   
 1.082 
 57, 021.04   1.074 
ln    MacD  ln  1.082 
 59,776.39   
MacD  6.3589
The modified duration is the Macaulay duration divided by the one-period accumulation
factor:
MacD 6.3589
ModD    5.9207
1y 1.074

Chapter 15: Asset-Liability Management
Solution 15.01
B Chapter 15.02, Dedication
The liability cash flows can be matched by purchasing 6 of the 1-year bonds and 15 of the
2-year bonds:
100 100
6  15   1, 969.36
1.03 1.042
Solution 15.02
C Section 15.02, Dedication
The present value of the asset cash flows is equal to the present value of the liability cash
flows, so the cost of the bonds is equal to the present value of the liability cash flows.
Since the yield is the same for both bonds, that yield can be used to calculate the present
value of the liability cash flows:
5, 000 7, 000
  11, 279.59
1.04 1.042
Solution 15.03
B Section 15.02, Dedication
The liability of 1,200 due in two years is met by arranging a payment of 1,200 in two
years from Loan B. Since Loan B makes an equal-sized payment at time 1, it also pays
1,200 at time 1. That leaves 1,800 of net liability at time 1 to be met by Loan A. The
amount lent is:
3, 000  1, 200 1, 200 1, 200
X Y     3, 914.36
1.05 1.06 1.062
Solution 15.04
We do not use the two-year 4% bond, because:
1. It has the lowest yield, and
2. It produces cash flow at time 1, reducing our ability the use the highest-yielding
bond, which is the 7% bond.
The smallest cost of assets that provide the necessary cash flows is:
10, 000 15, 000
  22, 822.58
1.07 1.0552
Solution 15.05
The quantity of Bond B to purchase is the quantity that produces a cash flow of $1,000 at
time 1:
1, 000
QB   0.9709
1, 030

Chapter 15: Asset-Liability Management Solutions to End of Chapter Questions
The quantity of Bond A to purchase is the quantity that produces the net liability
remaining after the payment from Bond B is received:
1, 000  30  0.9709
QA   0.9472
1, 025
Choice B is the correct answer.
Solution 15.06
A Section 15.02, Dedication
The quantity of Bond C that is purchased is:
107
QC 
104
The quantity of Bond A that is purchased is the amount needed to cover the remaining
liability after the cash flow from Bond C is received:
107
98  4
QA  104  0.894
105
Solution 15.07
D Section 15.02, Asset-Liability Management
The liability cash flows occur at time 1 and time 2 in the following amounts:
Time 1: 10,000  1.04  0.5  5,200
Time 2: 10, 000  1.04  0.5  1.04  5, 408
The strategy that costs the least to implement produces the highest profit. To answer this
question, we:
1. Determine the cost of each strategy.
2. Find the lowest cost strategy that provides the necessary cash flows.
The cost of each strategy is listed below:
A: 4,500  4,598  320  9, 418
B: 5, 000  4, 905  9, 905
C: 5, 000  5, 000  10, 000
D: 4,706  5,102  9, 808
E: 4, 723  290  4, 800  9, 813
Choice A has the lowest cost, so we check to see if it provides the necessary cash flows:
Time 1: 4,500  1.04  320  0.06  4, 699.2000
Time 2: 4,598  1.052  320  1.06  5, 408.4950
Since Choice A does not provide at least 5,200 in year 1, it is not correct.
Since Choice D has the next lowest cost, we check to see if provides the necessary cash
flows:
Time 1: 4, 706  1.04  5,102  0.06  5,200.3600
Time 2: 5,102  1.06  5, 408.1200
Choice D provides the necessary cash flows to make the liability payments, so Choice D is
the correct answer.

Solution 15.08
B Section 15.03, Redington Immunization
We don’t need to know the amount of the liability payment to answer this question.
The duration of the asset portfolio must be equal to the duration of the liability. Let X be
the percentage of the asset portfolio that is invested in the asset that pays at time 3:
3 X  10(1  X )  6
7 X  4
4
X 
7
Since the present value of the asset portfolio is equal to the present value of the liability,
the present values of the asset cash flows at time 0 are:
4
PVA   PVL
7
3
PVB   PVL
7
The time-3 and time-10 cash flows are found by accumulating their present values:
4
PVA  1.053  PVL  1.053
A 7 4
    0.9476
B PVB  1.0510 3 10 3  1.057
 PVL  1.05
7
Solution 15.09
E Section 15.03, Redington Immunization
We don’t need to know the amount of the liability payment to answer this question.
The duration of the asset portfolio must be equal to the duration of the liability. Let X be
the percentage of the asset portfolio that is invested in the asset that pays at time 5:
5 X  10(1  X )  9
5 X  1
1
X 
5
Since the present value of the asset portfolio is equal to the present value of the liability,
the present values of the asset cash flows at time 0 are:
1
PVA   PVL
5
4
PVB   PVL
5
The time-10 and time-5 cash flows are found by accumulating their present values:
4
10  PVL  1.0510
B PVB  1.05 5
   4  1.055  5.1051
A PVA  1.055 1 5
 PVL  1.05
5

Solution 15.10
E Section 15.03, Immunization
The Macaulay duration of the liabilities is:
 t  PV0 CFt  374.11 1 

374.11
2
2 
374.11
3
MacDurL  t  0 
1.06 1.06 1.063  1.9612
 PV0 CFt  1, 000
t 0
The Macaulay duration of the assets must be equal to the Macaulay duration of the
liabilities. Let w be weight of the one-year bond:
w  3(1  w )  1.9612
w  0.51941
The amounts to invest in the one-year bond and the 3-year bond are:
One-year bond: 1, 000w  1, 000  0.51941  519.41
Three-year bond: 1, 000(1  w )  1, 000(1  0.51941)  480.59
Solution 15.11
C Section 15.03, Redington Immunization
All of the answer choices have the same present value as the present value of the
liabilities, so we’ll focus on the requirements that the Macaulay duration of the assets be
equal to that of the liabilities and that the Macaulay convexity of the assets be greater
than that of the liabilities.
For Choice A, the Macaulay duration of the assets is not equal to the Macaulay duration of
the liabilities:
1, 000 4, 000
MacDA  5   10  9
5, 000 5, 000
For Choice B, the Macaulay duration of the assets is not equal to the Macaulay duration of
the liabilities:
2, 000 3, 000
MacDB  5   20  14
5, 000 5, 000
For Choice C, we have:
2, 666.67 2, 333.33
MacDC  5   20  12
5, 000 5, 000
2, 666.67 2,333.33
MacCC   52   202  200
5, 000 5, 000
Since the Macaulay duration of the assets is equal (within rounding tolerance) to the
Macaulay duration of the liabilities, and the Macaulay convexity of the assets is greater
than the Macaulay convexity of the liabilities, Choice C is the correct answer.
For Choice D, the Macaulay duration of the assets is not equal to the Macaulay duration of
the liabilities:
3, 000 2, 000
MacDD   10   20  14
5, 000 5, 000

For Choice E, the Macaulay convexity is not greater than the Macaulay convexity of the
liabilities:
4, 000 1, 000
MacDE   10   20  12
5, 000 5, 000
4, 000 1, 000
MacCE   102   202  160
5, 000 5, 000
Solution 15.12
C Section 15.01, Interest Rate Risk
On 12/31/2027, the company will receive the par value of 821,972.11, leaving the
following net liability:
1, 000, 000  821, 927.11  178, 072.89
Under Scenario A, the profit is:
0.04  821, 927.11  s5 0.037  178, 072.89
1.0375  1
 0.04  821, 927.11   178, 072.89
0.037
 1, 064.47
Under Scenario B, the profit is:
0.04  821, 927.11  s5 0.043  178, 072.89
1.0435  1
 0.04  821, 927.11   178, 072.89
0.043
 1, 070.76
Choice C best describes the company’s profit or loss.
Solution 15.13
A Section 15.03, Redington Immunization
The present value, Macaulay duration, and Macaulay convexity of the liabilities are:
595.51 709.26
PVL    1, 000.0020
3
1.06 1.066
 t  PV0 CFt  595.51
3
3
709.26
6
6
MacDL  t 0
 1.06 1.06  4.5000
 PV0 CFt  1, 000.0020
t 0
 t 2  PV0 CFt  595.51

3
 32 
709.26
6
 62
MacCL  t  0
 1.06 1.06  22.5000
 PV0 CFt  1, 000.0020
t 0
The present value, Macaulay duration, and Macaulay convexity of Choice A are:
PVA  500  500  1, 000
MacDA  0.5  1  0.5  8  4.5
MacC A  0.5  12  0.5  82  32.5

Since the present value and the Macaulay duration of Choice A are equal (within rounding
tolerance) to the present value and Macaulay duration of the liabilities, and the Macaulay
convexity of Choice A exceeds the Macaulay convexity of the liabilities, Choice A is the
correct answer.
Choice B’s Macaulay duration can be found as the weighted average of the timing of its
cash flows:
MacD0B  0.400  1  0.600  8  5.2
Since 5.2 is not equal to the duration of the liabilities, Choice B is not correct.
Choices C and D have present values that are not equal to the present value of the
liabilities, so neither is correct.
Choice E has a single cash flow, so its Macaulay convexity is equal to the square of the
time of the cash flow:
MacCE  4.52  20.25
Since 20.25 is less than the Macaulay convexity of the liabilities, Choice E is not correct.
Solution 15.14
D Section 15.03, Redington Immunization
The Macaulay duration of the asset is:
  15v15
 t  PV0 CFt  700(Ia) a15
66.0721
MacD  t 0
 15
 0.062 
 PV0 CFt  700 a15
9.5866 9.5866
t 0
 6.8921
Let’s define X to be the weight of the liability cash flow that occurs at time 10. Since the
position satisfies the conditions of Redington immunization, the duration of the liabilities is
equal to the duration of the asset:
6.8921  10 X  (1  X )5
X  0.3784
The expression above for X can now be used to find the value of B:
B
10
0.3784  1.062
700a15
B
0.3784  6,710.6060 
1.06210
B  4, 634.3653
The BA II Plus can be used to answer this question:
15 [N] 6.2 [I/Y] 1[PMT] [CPT] [PV] [+/-]
Result is 9.5865.
[STO] 1 [] 1.062 [] 15 [] 1.062 [yx] 15 [=] [] 0.062 [=]
Result is 66.0721.
[] [RCL] 1 [=]
Result is 6.8921.
[] 5 [=] [] 5 [=]
Result is 0.3784.
[] [RCL] 1 [] 700 [] 1.062 [yx] 10 [=]

Solution 15.15
A Section 15.03, Redington Immunization
The present value, Macaulay duration, and Macaulay convexity of the liabilities are:
600 1,500
PVL    1, 746.7178
1.05 1.055
 t  PV0  CFt  
 
600
1.05
1 
1,500
5
5
MacDL  t 0
 1.05  3.6914
 PV0  CFt  1,746.7178
t 0
 t 2  PV0 CFt  1.05

600
 12 
1,500
5
 52
MacCL  t 0
 1.05  17.1485
 PV0 CFt  1,746.7178
t 0
Since the duration of the assets is equal to the duration of the liabilities, the average
duration of the assets is 3.6914. Let the weight of the cash flow of X be w:
0  w  (1  w)  6  3.6914
w  0.3848
Since the cash flow of X occurs at time 0, the value of X is its weight times the present
value of the liabilities:
X  0.3848  1, 746.7178  672.0720
The Macaulay convexity of the assets is:
 t 2  PV0 CFt 

MacC A  t  0  w  02  (1  w)  62
 0 t
PV  CF 
t 0
 0.3848  0  (1  0.3848)  36  22.1485
Since the Macaulay convexity of the assets is greater than the Macaulay convexity of the
liabilities, the conditions of Redington immunization are satisfied. Choice A is the correct
answer.
Solution 15.16
A Section 15.04, Asset-Liability Management
A is false, because the modified duration is the Macaulay duration divided by the sum of
one and the periodic effective yield, where the period is determined by the compounding
frequency of the yield. Choice A is the correct answer.
B is true, because as the compounding frequency increases to infinity, the compounding
periods become smaller, and the periodic effective yield approaches zero.
C is true because in a cash flow matched portfolio, the present value of the liabilities is
equal to the present value of the assets, and the duration of the liabilities is equal to the
duration of the assets.
D is true because the first two conditions of a fully immunized portfolio are the same as
the first two conditions of a Redington immunized portfolio (see the preceding paragraph
regarding Choice C).
E is true, because fully immunized portfolios are a subset of Redington immunized
portfolios.

Solution 15.17
D Section 15.04, Full Immunization
The duration of the asset portfolio must be equal to duration of the liability. Let w be the
percentage of the asset portfolio that is invested in the asset that pays at time 2:
2w  8(1  w)  5
6w  3
w  0.5
The present value of A is therefore one half of the present value of the liability. The
present value of B is also one half of the present value of the liability:
A 7, 000
 0.5   A  3,156.7995
2
1.035 1.0355
B 7, 000
 0.5   B  3, 880.5126
1.0358 1.0355
The absolute value of the difference is:
A  B  3,156.7995  3, 880.5126  723.7131
Solution 15.18
C Section 15.04, Full Immunization
Let w be the weight of the first asset cash flow:
200
5
w  1.03  0.2122
1, 000
1.037
liability:
5w  y(1  w)  7
5(0.2122)  y(1  0.2122)  7
y  7.5387
The present value of the assets must be equal to the present value of the liabilities:
200 B 1, 000
 
5 7.5387
1.03 1.03 1.037
B  800.46
Solution 15.19
C Section 15.04, Full Immunization
Let w be the weight of the first asset cash flow:
7, 000
4
w  1.04  0.5678
15, 000
1.049

liability:
4w  (9  y )(1  w)  9
4(0.5678)  (9  y )(1  0.5678)  9
y  6.5680
The present value of the assets must be equal to the present value of the liabilities:
7, 000 Y 15, 000
 
4 9  6.5680
1.04 1.04 1.049
Y  8,388.3965
The ratio is:
Y 8,388.3965
  1, 277.17
y 6.5680

Chapter 16: Term Structure of Interest
Rates
Solution 16.01
C Section 16.02, Spot Rates
The value of the bond is:
50 50 1, 050
   949.23
1.05 1.062 1.073
Solution 16.02
E Section 16.02, Spot Rates
We can use the BA-II Plus calculator to answer this question:
50 [] 1.05 [+] 50 [] 1.06 [x2] [+] 1,050 [] 1.07 [yx] 3 [=]
[+/-] [PV] 3 [N] 50 [PMT] 1,000 [FV]
[CPT] [I/Y]
(Result is 6.9321)
Answer is 6.93%.
Solution 16.03
Lending annually at 3.0% for 6 years is clearly an inferior strategy, because 3.0% is the
lowest possible rate. Likewise, lending annually for 3 years at 3.0% and for one 3-year
period at 4.0% is clearly inferior to lending for 6 years (two 3-year periods) at 4.0%.
The remaining viable strategies that must be compared are:
Lend for 6 years (two 3-year periods) at 4.0%. This results in an accumulation factor of:
24
 0.04 
1    1.2697
 4 
Lend for 1 year at 3.0% and 5 years at 4.4%. This results in an accumulation factor of:
4 5 4
 0.03   0.044 
1   1    1.2823
 4   4 
Since the second strategy has a higher accumulation factor, it produces the maximum
annual effective rate, which is:
1.28231/6  1  4.23%
Solution 16.04
B Section 16.02, Spot Rates
The price of a zero-coupon bond as a percentage of its redemption value is equal to the
inverse of the accumulation factor achieved by investing in the bond.

Chapter 16: Term Structure of Interest Rates Solutions to End of Chapter Questions
Therefore investing X in the 5-month bond, for example, results in an accumulated value
of:
X
0.95
Investing X in each of the bonds results in an accumulated value of:
X X X X X
   
0.95 0.96 0.97 0.98 0.99
 1 1 1 1 1 
 X       5.1557 X
 0.95 0.96 0.97 0.98 0.99 
Setting this accumulated value equal to 10,000 allows us to solve for X:
5.1557 X  10, 000
X  1, 939.59
Solution 16.05
B Section 16.03, Forward Rates
The spot rates can be used to calculate the forward rate:
(1  st )t
1  ft 1 
(1  st 1 )t 1
(1  s2 )2
1  f1 
1  s1
1.0852
1  f1 
1.075
f1  9.51%
Solution 16.06
D Section 16.03, Forward Rates
We are being asked for f2 :
(1  st )t
1  ft 1 
(1  st 1 )t 1
(1  s3 )3
1  f2 
(1  s2 )2
1
1  f2  0.85
1
0.92
f2  8.24%

Solution 16.07
E Section 16.03, Forward Rates
The question is asking for the rate that applies from time 5 to time 6.
(1  st )t
1  ft 1 
(1  st 1 )t 1
1.0956
1  f5 
1.095
f5  12.03%
Solution 16.08
E Section 16.03, Forward Rates
The loan will be made at the interest rate that can be locked in to apply from time 3 to
time 4. This is the 1-year forward rate, deferred for 3 years:
(1  st )t
1  ft 1 
(1  st 1 )t 1
1.0854
1  f3 
1.083
f3  0.1001
The accumulated value of the loan at time 4 is:
1, 000  1.1001  1,100.14
Solution 16.09
D Section 16.03, Forward Rates
The loan will be accumulated from time 3 to time 4 and from time 4 to time 5.
The 1-year forward rate, deferred for 3 years is found below:
(1  st )t
1  ft 1 
(1  st 1 )t 1
1.0854
1  f3 
1.083
f3  0.1001
The 1-year forward rate, deferred for 4 years is found below:
(1  st )t
1  ft 1 
(1  st 1 )t 1
1.0905
1  f4 
1.0854
f4  0.1102
The accumulated value of the loan at time 5 is:
1, 000  1.1001  1.1102  1, 221.41

Solution 16.10
B Section 16.03, Forward Rates
The 3-year accumulation factor calculated with the spot rate is the same as the 3-year
accumulation factor calculated with the forward rates:
(1  st )t  (1  f0 )(1  f1 )  (1  ft 1 )
(1  s3 )3  (1  f0 )(1  f1 )(1  f2 )
(1  s3 )3  1.05  1.03  1.02
s3  3.33%
Solution 16.11
A Section 16.03, Yield, Spot, and Forward Rates
I. True. When the price of a bond is equal to its par value, there is no premium or
discount to compensate for the coupon rate being greater than or less than the yield.
Therefore, the coupon is equal to the yield.
II. False. If the spot rates used to discount the cash flows occurring before time n are
greater than the n-year spot rate, then the yield on the n-year bond will be greater than
the n-year spot rate.
III. False. If the (n – 1)-year spot rate is greater than the 1-year forward rate
deferred for (n – 1) years, then the n-year spot rate will be greater than the 1-year
forward rate deferred for (n – 1) years.
Solution 16.12
C Section 16.03, Forward Rates
The forward rate j applies from time 4 to time 5:
(1  s5 )5 (1  0.02  0.001  5  0.001  25)5
j  f4,1  f4  1  1
(1  s4 )4 (1  0.02  0.001  4  0.001  16)4
1.0405
  1  7.26%
1.0324
Solution 16.13
The payments occur at times 2, 3, and 4. The present value at time 0 of the annuity is:
10, 000 10, 000 10, 000
PV0     26, 668.5525
2 3
1.035 1.039 1.0444
The present value at time 0 can be accumulated for one year using the one-year spot rate
to find the current value of the annuity in one year:
CV1  26, 668.5525  1.03  27, 468.61
Solution 16.14
A Section 16.03, Forward Rates
Bond B must produce a cash flow at time 2 that is sufficient to grow to 5,000 at a 5.5%
interest rate:
5, 000
 4, 739.3365
1.055

The combined prices of Bond A and Bond B are:

3, 000 4,739.3365
  7,183.33
1.04 1.052

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Solutions to End of Chapter

Questions (Third Edition)

Chapter 1: Setting the Stage

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To find the point at which X is maximized, we take the derivative of X:

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We set the derivative equal to zero to find the local maximum:

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We now solve for n:

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The present value of 6,000 at time (t +1) is:

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The present value of the payment is:

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Setting Patty’s interest equal to Sally’s interest allows us to solve for i:

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We can now find the present value of Heidi’s loan:

t ln(1.03)  ln(2)  3t ln(1.005)

1,500  1,5002  4(3, 000)(3, 445.1494)

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1,500  1,5002  4(3,100)(3, 431.2244)

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c. The annual interest rate compounded monthly is:

d. The annual effective discount rate is:

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Let’s use the following substitution:

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The integral is:

Let’s evaluate the integral in the expression above:

Let’s use the following substitution:

The accumulated value of Fund B at time t is:

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To evaluate the integral, let’s use the following substitution:

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The present value is:

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The accumulation function is:

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The BA-II Plus can be used to solve the problem as follows:

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The BA-II Plus can be used to solve the problem as follows:

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