Actuarial Society of India

Subject 102
November 2001 examination
INDICATIVE SOLUTIONS

Q.1
i (12) = 10%p.a Payable monthly
12
 i (12) 
i= 1+  −1
 12 
= 0.10471
1
d=1-v=1- = 0.09479
(1+ i )
1 − v15 1 − v15
(i ) a
..
( 4)
= =
15
d ( 4)  1

4 1 − (1-d ) 4 
 
1-0.2245
= = 7.8843
0.09836
n−a
( ii) Dα( 2)10 = ( 2) n
i
 i (12 )  
i( ) = 2  1 +  − 1 = 0.1021
2

 12  
10-6.022
Dα( 2 )10 = = 38.9572
0.1021

1000 2000 1500

Qn.2. *---------------------*----------------*------------*---------------*------------*--------*
1.1.99 1.1.2000 1.7.00 31.10.00 1.1.01 30.9.01 1.1.02
[ 6% Hly. ] [ 4% mthly. ] [ 5% p.a. ]

i1 (2) i2 (12) i3

The money Gopal will receive is the accumulation of the above cash flow till
30th sep 2001.
  i ( 2 ) 
2
  i (12) 
12

1000  1 + 1   1 + 2  ( 1 + i3 ) 12
9
 
 2    12  
  
 
(12 ) 6

i  (1 + i3 ) 9 12
+2000  1 + 2

  2  
  
  i (12 )  
2

+1500  1 + 2   (1 + i3 ) 12
9

 2  
 

Putting in the values of i1( 2 ) , i2 (12 ) & i3 we get

= (1000 × 1.0609 ×1.0407 ×103727 )

+ ( 2000 × 1.02017 × 1.03727)
+ (1500 × 1.006678× 1.03727 )
= 4827.91 = 48.28

Q.3
..
sn − n
( Is ) n =
i

If a sum of 1 is invested in a bank account at the beginning of each year for n

years. The investor, in order to receive an yield of i p.a. he will expect to receive
interest at rate i at end of each year on the amount invested plus a return of the
total capital invested at the end of n years.
Since 1 is invested each year, the accumulated value of the amount invested is sn
The interest payment are i in the first year, 2i the second year and so on and the
capital return at the end is of amount n. T he accumulated value of the proceeds of
investment is therefore.
i ( Is ) n + n
Since the yield is i, the accumulated values of the investment equals the
accumulated value of the proceeds.
i. e., s n = i(Is) n + n
Re arranging , we get
s −n
(Is)n = n
i
Q.4. The purchase price of a Rs 100 bond is 102. There is a loss in redemption. Under
optional redemption bonds, loss should be postponed to the maximum term
possible.
Hence Priya should redeem the bond at the end of 15th year.
The equation of value is :
102 = 10a (2)15 + 100v 15 @ i
By hit & trial method
@ i = 9%R H S= 109.84
@ i = 10%R H S = 101.85
On int erpolatingi = 9.98%

(i) Futures.

A future contract is a standardised, exchange tradable contract between two

parties to trade a specified asset on a set date in the future at a specified price.
Futures can exist on many different underlying assets. Financial futures are based
on an underlying financial instrument, rather than a physical commodity.

(ii) Margins

Each party to a futures contract must deposit a sum of money known as “margin”
with the clearing house. Margin payments act as cushion against potential losses
that the parties may suffer from future adverse price movements.
When the contract is first struck “initial margin” is deposited with the
clearinghouse. Additional payments of “Variation margin” are made daily to
ensure that the clearing houses exposure to credit risk is controlled. This exposure
can increase after the contract is struck through subsequent adverse price
movement.

(iii) Swaps

A swap is a contract between two parties under which they agree to exchange a
series of payments according to a pre-arranged formula.
Swaps could be of two types, interests rate swaps & currency swaps.
In most common form of interest rate swap, one party agrees to pay to the other a
regular series of fixed amount for a certain term. In exchange, the second party
agrees to pay a series of variable amounts based on the level of a short-term
interest rate. Both sets of payments are in the same currency.

A currency swap is an agreement to exchange of fixed series of interest payments

and a capital sum in one currency for a fixed series of interest payments and a
capital sum in another.

(iv)Discrete time forward rates

The discrete time forward rate, for f t,r is the annual interest rate agreed at time 0
for an investment made at time t>0 for a period of r years.
That is if an investor agrees at time 0 to invest Rs 100 at time t for r year, the
accumulated investment at time
 t + r is 100 ∗ (1 + f t , r ) r

Q6
The equation of value is
( 2)
(1 − 0.30) ∗12 a10 + 120v10 − 0.40(120 − 100) v10 @10%
52.8727 + 46.2652 − 30848 = 96.05

Q7
Let P & Q denote the maturity values of the 5 year and 12 year zero coupon
bonds. Then the present value of assets is:
VA (0.09) = Pv5 + Qv12 @9% = 0.6499P + 0.3555Q
Present value of the liabilities, which is :
VL (0.09) = 100,000 v6 +120,000 v9 @9%
= 59627 + 55251 = 114878

This gives us one first equation for finding P & Q

0.6499P + 0.3555Q = 114878………….(1)
The negative of derivative of the present value of the assets is given by
−VA' (0.09) = P.5v 6 + Q.2v 13 @9%
= 2.9831P + 3.91414Q

So volatility of assets is
−VA' (0.09) 2.9813P+3.91414Q
=
VA (0.09) 114878

By Redington’s second condition, this must equal the volatility of the liabilities
which is:
−VL' (0.09) 100000*6v 7 + 120000*9v10
=
VL (0.09) 114878
328220 - 456204 784424
= =
114878 114878

This gives the second equation for finding P & Q

2.9813P + 3.91414 Q – 784424 ….. (2)

Solving for equations (1) & (2) we get

P = 115088
Q = 112748

This determines the portfolio of assets we require. We now need to check

Redington’s 3rd conditions with these values of P & Q the convexity of assets is:
 VA" (0.09) P*5*6v7 + Q.12*13v14
= @9%
VA (0.09) 114878

=(1888712 + 5263353) / ( 114878 ) = 62.26

The convexity of liabilities is

VL" (0.09) 100000*6*7v8 + 120000*9*10 v11
=
VL (0.09) 114878
2107838 + 4185355
= = 54.78
114878

Since the convexity of the assets exceeds the convexity of the liabilities, all the
three of Redington’s credit are now satisfied and the fund is immunized against
small changes in the interest rate around 9%
(8)

Q.8
Inflows

20000 20000 20000 20000 200000

0 1 2 3 4 5

Outflows

150000 20000 15000

0 1 2

The equation of value is

-150000 – 20000v – 15000v2 + 20000 a4 + 200000 v5 @ i%

by hit and trial method

@ 10% equation = 7003.06
@ 11% equation = 546.82

by interpolation
( 0.11 − 0.10 )
* ( 0 − 546.82 )
0.11+ ( 546.82 − 7003.06 )
= 11.1%
Qn.9.
1 1.1 1.12 1.13 1.14

0 1 2 3 4 5

i ( 2 ) = 8%
 1( 2 ) 
2 2
 0.08 
i =  1 +  − 1 = 1 + − 1 = 8.16%
 2   2 

Accumulated value is

1s (12 )1 (1 + i ) + ( 1.1) s (12) 1 (1 + i ) + ( 1.1) s (12) 1 ( 1 + i )

4 3 2 2

+ (1.1) s (12 )1 (1 + i ) + (1.1) s (12)1

3 4
@8.16%
(1 + i ) − 1
where s (12)1 = = 1.0368
i (12)
The accumulated value is

1.0368 [1.3686+1.3919+1.41553+1.4396+1.4641]
= 7.3403

Q.10
(a) Money weighted rate of return
2.0 (1 + .i ) + 0.4 (1+i )
3 1
2
= 3.4 @ i%
By hit & trial method
@ 8% LHS = 2.9351
@ 9% LHS = 3.01

by interpolation

i.= 14.21%

(b) These weighted rate of return

( 2.7 − 0.4 ) * 3.4 = 1.4481
(1 + i ) =
3

2.0 2.7
 (c) Linked rate of return.
There were no cash flows during 98 or 99 so the values for (1+i) is

2.3
98 (1 + i 9 8 ) = = 1.15
2.0
2.7
99 (1+i99 ) = = 1.174
2.3
2000 2.7 (1+i 1 0 0 ) + 0.4 (1 + i )
1
2
= 3.4
by hit & trial method & interp olation
i 00 = 0.1010
Linked rate of return i is
(1+i )
3
( )
= 1 + i 98 * (1 + i99 ) * (1 + i00 )
= 1.15*1.174*1.1010
hence i = 14.13%

Q.11) (i)
t
−
∫0 δ ( s )d s
vt = e
for 0 ≤ 1 < 5
t
− ∫0 0 . 0 5 d s
vt = e = e −0.05t
for 5 ≤ t < 8
 5 t 
 − ∫ 0 . 0 5d s − ∫ 0 . 0 6d s 
 0 − 5

 
v t
= e  

= e - 0 . 0 5 * 5 - 0 . 0 6 (t - 5 ) = e 0 . 0 5 − 0 . 0 6 t
for t ≥ 8
 5
− ∫ 0 . 0 5d s
8 t
− ∫ 0 . 0 6d s - ∫ 0.07 ds

 
 0 − 5 8

 
= e  
t
v
-  0 . 0 5 ( 5 - 0 ) + 0 . 0 6 ( 8 − 5 ) + 0 . 0 7 ( t − 8 )
= e
(0 . 1 3 - 0 . 0 7 t )
= e

Hence Equation for vt =

 e −0.05t 0≤ t < 5
V= t
e 0.05-0.06t
5≤ t < 8
e 0.13-0.07t
8 ≤ t < 20

(ii) * * * * *
t=0 t=4 t=5 t=8 t=18

[ ] [ ] [ ]
ä =0.05 ä=0.06 ä=0.07

50000*(1+i) (18-4) = 50000 *v4 /v18

From the above equation,

50000 * (e –0.05*4 ) / e 0.13-0.07*18

= 50000*0.8187/ 0.3230 = 126739.

(iii)

50000 e14 δ =126739

126739
e 14 δ = = 2.5348
50,000
hense δ =6.64%
(iv)
v 2 0 = e0 . 1 3 −0 . 0 7 * 2 0
v 2 0 = e −1.27
i = 6.56%

Qn.12. Total amount of interest

12.5
*300,000 × 2 = 75000
100
The total amount repaid would be
300000 + 75000 = 375000
375000
Monthly repayment = 15625
24
The equation of value (in monthly time periods)
15625a 24 = 19.2012
By hit and trail method and interpolation,

i=1.875%
 A.P.R=22.5%

Qn.13.

If the assumed inflation rate is ‘e’.

The equation of value is

12470 1.08
a = 100000 @i= −1
(1 + e ) 10 (1+e )
a10
= 8.019
1+ e
 1.08 
1 + e  a10 = 8.019*1.08

By hit and trial method and interpolation

i = 3.35%
then 0.0835= { 1.08 / (1+e) }- 1

e = 4.5%

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