The Theory of Interest - Solutions Manual

Chapter 3

Chapter 3
1. The equation of value using a comparison date at time t 20 is
50, 000 1000 s20 Xs10 at 7%.
Thus,
50,000 1000s20 50,000 40,995.49
X

$651.72.
s10
13.81645
2. The down payment (D) plus the amount of the loan (L) must equal the total price paid
for the automobile. The monthly rate of interest is j .18 /12 .015 and the amount
of the loan (L) is the present value of the payments, i.e.
L 250a48 .015 250 34.04255 8510.64.
Thus, the down payment needed will be
D 10,000 8510.64 $1489.36.
3. The monthly interest rate on the first loan (L1) is j1 .06 /12 .005 and
L1 500a48 .005 500 42.58032 21, 290.16.

The monthly interest rate on the second loan (L2) is j2 .075 /12 .00625 and
L2 25,000 L1 25,000 21, 290.16 3709.84.
The payment on the second loan (R) can be determined from
3709.84 Ra12 .00625
giving
3709.84
R
$321.86.
11.52639

4. As loan: 20,000 Ra8 .085

20,000
3546.61
5.639183
so that the total interest would be
8 3546.61 20,000 8372.88.
R

Bs loan: The annual interest is

.085 20,000 1700.00
so that the total interest would be
8 1700.00 13,600.00.
Thus, the difference is
13,600.00 8372.88 $5227.12.

23

The Theory of Interest - Solutions Manual

Chapter 3

5. Using formula (3.2), the present value is

n
n 1 1 i
1
nan
where i .
i
n
This expression then becomes
n

n 1
n 1
n

n
n
2

n 1
.
1
n 1

n
n
1 v
1 v2n
6. We are given an
x, so that v n 1 ix. Also, we are given a2 n
y,
i
i
2
2
so that v 2 n 1 iy. But v 2n v n so that 1 iy 1 ix . This equation is the
2x y
. Then applying formula (1.15a), we
quadratic x 2i 2 2 x y i 0 so that i
x2
i
2x y
2
.
have d
1 i x 2x y
7. We know that d 1 v, and directly applying formula (3.8), we have
8
8
1 v8 1 1 d
1 .9
&
&
a8

5.695.
d
d
.1
8. The semiannual interest rate is j .06 / 2 .03. The present value of the payments is
&
&
100 a&
a&
100 15.87747 8.01969 $2389.72.
21
9
9. We will use a comparison date at the point where the interest rate changes. The
equation of value at age 65 is
&
&
3000s&
Ra&
25 .08
15 .07
so that

3000&
s&
236,863.25
25 .08

$24,305
&
a&
9.74547
15 .07

to the nearest dollar.

10. (a) Using formulas (3.1) and (3.7)
&
a&
1 v v 2 L v n 1 v n v n
n

v v 2 L v n 1 v n an 1 v n .

(b) Using formulas (3.3) and (3.9)

24

The Theory of Interest - Solutions Manual

Chapter 3

&
s&
1 i 1 i
n
n

1 i

n 1

n 1

L 1 i 1 1

L 1 i 1 1 i 1
n

sn 1 1 i .
n

(c)

Each formula can be explained from the above derivations by putting the
annuity-immediate payments on a time diagram and adjusting the beginning and
end of the series of payments to turn each into an annuity-due.

11. We know that

1 vp
&p x
a&
d

and sq

1 i
y

Thus, v p 1 dx 1 ivx and 1 i 1 iy, so that v q 1 iy .

1

Finally,

a pq

1 v pq 1
1 ivx

1
i
i
1 iy

1 iy 1 ivx vx y

.
i 1 iy
1 iy

t 0
12. We will call September 7, z 1
so that
March 7, z 8 is t 34
and
June 7, z 12 is t 51
where time t is measured in quarters. Payments are made at t 3 through t 49,
inclusive. The quarterly rate of interest is j .06 / 4 .015.
(a)
(b)
(c)

PV 100 a49 a2 100 34.5247 1.9559 $3256.88.

CV 100 s32 a15 100 40.6883 13.3432 $5403.15.

AV 100 s49 s2 100 71.6087 2.0150 $6959.37.

13. One approach is to sum the geometric progression

a45
1 v 45
15
30

a15 1 v v a15

a
a45 .
15
1 v15
a15
The formula also can be derived by observing that
a15 1 v15 v 30 a15 15 a15 30 a15 a45
by splitting the 45 payments into 3 sets of 15 payments each.

25

The Theory of Interest - Solutions Manual

Chapter 3

14. We multiply numerator and denominator by 1 i to change the comparison date

from time t 0 to t 4 and obtain
4
a7
a7 1 i
a s4

3
.
4
a11 a 1 i
a7 s 4
11
Therefore x 4, y 7, and z 4.
4

15. The present value of annuities X and Y are:

PVX a30 v10 a10 and

PVY K a10 v 20 a10 .

We are given that PVX PVY and v10 .5. Multiplying through by i, we have
1 v 30 v10 1 v10 K 1 v10 1 v 20
so that
1 v10 v 20 v 30 1 .5 .25 .125 1.125
K

1.8.
1 v10 v 20 v 30 1 .5 .25 .125 .625
16. We are given

a10 3 10 a5 or v 5 a10 3v10 a5 and v 5

1 v10
1 v5
3v10
.
i
i

Therefore, we have

v 5 v15 3v10 3v15 or 2v15 3v10 v5 0 or 2 3 1 i 1 i 0

5

10

which is a quadratic in 1 i . Solving the quadratic

5

1 i
rejecting the root i 0.

2
3 3 4 2 1 3 1

2
2
2

17. The semiannual interest rate is j .09 / 2 .045. The present value of the annuity on
October 1 of the prior year is 2000a10 . Thus, the present value on January 1 is
.5
2000a10 1.045

2000 7.91272 1.02225 $16,178

to the nearest dollar.
18. The equation of value at time t 0 is
&
&
1000a&
R v 30 a&
20

or
1 v 20
1
1000
R v 30
d
d
so that
26

The Theory of Interest - Solutions Manual

Chapter 3

1 v 20
30
R 1000 30 1000 1 v 20 1 i
v
30
10
1000 1 i 1 i .
1
i
1
. The equation of value at time t 0 is
so that d
9
1 i 10
1 d n 1 .1 n
n
&
6561 1000v a&
or 6.561

d
.1
Therefore, .9 n .1 6.561 .6561 and n 4.

19. We are given i

20. The equation of value at age 60 is

50, 000a Rv 5 a20
or
50, 000
1 v 20
Rv 5
i
i
so that
50,000
R 5 25 at i .05
v v
50, 000

$102, 412
.7835262 .2953028
to the nearest dollar.
21. Per dollar of annuity payment, we have PVA PVD which gives
1
an v n a or an 3v n a
3
n
n
and 1 v 3v , so that

4v n 1 or v n .25 and
22. Per dollar of annuity payment, we have
PVA an , PVB v n an , PVC v 2 n an

1 i

PVC
v 2 n .49 or v n .7.
PVA

27

4.

and PVD v 3n a .

We are given

Finally,

The Theory of Interest - Solutions Manual

Chapter 3

n
PVB v an
vn 1 vn
3n
PVD v a
v 3n

a5.25
23. (a)

(b)

(c)

1 v n 1 .7 .30 30

.
v2n
.7 2 .49 49

1 i .25 1
a5 v
at i .05

1.05 .25 1
4.32946 .77402
4.5195.
.05

5.25

a5.25 a5 .25v 5.25

4.32946 .25 .77402 4.5230.
a5.25 a5 .25v 6
4.23946 .25 .74621 4.5160.

24. At time t 0 we have the equation of value

1000 100 an a4 or

an 10 a4 13.5875 at i .045.
Now using a financial calculator, we find that n 21 full payments plus a balloon
payment. We now use time t 21 as the comparison date to obtain
21
1000 1.045 100s17 K
or
21
K 1000 1.045 100s17
2520.2412 100 24.74171 46.07
Thus, the balloon payment is
100 46.07 $146.07 at time t 21.
25. We are given PV1 PV2 where
PV1 4a36

and PV2 5a18 .

We are also given that 1 i 2. Thus, we have

n

1 v 36
1 v18
4
5
i
i

or

4 1 v 36 4 1 v18 1 v18 5 1 v18 .

Thus, we have
28

The Theory of Interest - Solutions Manual

Chapter 3

4 1 v18 5 or v18 .25.

Finally, we have 1 i 4, so that 1 i 2 which gives n 9.
18

26. At time t 20, the fund balance would be

500&
s&
24,711.46 at i .08.
20
Let n be the number of years full withdrawals of 1000 can be made, so that the
equation of value is
1000 sn 24,711.46 or sn 24.71146 .
Using a financial calculator we find that only n 14 full withdrawals are possible.
27. (a) The monthly rate of interest is j .12 /12 .01. The equation of value at time
t 0 is
6000v k 100a60 4495.5038

v k .749251 so that k

ln .749251
29.
ln 1.01

(b) Applying formula (2.2) we have

1000 1 2 L 60 60 61 61
t

30.5.
100 60
2 60
2
28.(a)

Set: N 48 PV 12, 000 PMT 300 and CPT I to obtain j .7701%. The
answer is 12 j 9.24%.

(b) We have 300a48 12,000 or a48 40. Applying formula (3.21) with n 48 and
g 40, we have
2 n g 2 48 40
j

.8163%.
g n 1 40 48 1
The answer is 12 j 9.80%.
29. We have
a2 v v 2 or 1.75 1 i

1 i .

Multiplying through 1 i 2 gives

1.75 1 i 1 i 1
2

1.75 1 2i i 2 2 i
and 1.75i 2 2.5 .25 or 7i 2 10 1 0 which is a quadratic. Solving for i

29

The Theory of Interest - Solutions Manual

Chapter 3

2
10 10 4 7 1 10 128
i

2 7
14

4 2 5
rejecting the negative root.
7

30. We have the following equation of value

10, 000 1538a10 1072a20 .
10
Thus 1538 1 v10 1072 1 v 20 1072 1 v10 1 v10 , so that 1 v

v10 .43470.
Solving for i, we obtain
10
1 i .43470

and i .43470

.1

1538
or
1072

1 .0869, or 8.69%.

31. We are given that the following present values are equal
a 7.25% a50 j an j 1.
Using the financial calculator

1
13.7931
.0725
and solving we obtain j 7.00%. Since j 1 6%, we use the financial calculator
again
an 6% 13.7931 to obtain n 30.2.
a50 j

32. (a) We have j1 .08 / 2 .04 and j2 .07 / 2 .035. The present value is

a6 .04 a4 .035 1.04

5.2421 3.6731 .79031

8.145.

(b) The present value is

6
a6 .04 a4 .035 1.035 5.2421 3.6731 .81350

8.230.
(c) Answer (b) is greater than answer (a) since the last four payments are discounted
over the first three years at a lower interest rate.
33. (a) Using formula (3.24)
a5 v v 2 v 3 v 4 v 5

1
1
1
1
1

2
3
4
1.06 1.062
1.064
1.066
1.068 5
4.1543.

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The Theory of Interest - Solutions Manual

Chapter 3

(b) Using formula (3.23)

1
1
1
1
a5

1.06 1.06 1.062 1.06 1.062 1.064 1.06 1.062 1.064 1.066
1

4.1831.
1.06 1.062 1.064 1.066 1.068
34. Payments are R at time t .5 and 2R at time t 1.5, 2.5,K , 9.5. The present value of
these payments is equal to P. Thus, we have
4
1
P R 1 2 a4 i 2 a a j 1 i 1 i 2

and
1
P1 i 2
R
.
4
1 2a4 i 2 1 i a5 j
35. The payments occur at t 0, 1, 2,K , 19 and we need the current value at time t 2
using the variable effective rate of interest given. The current value is
1
1
1
1
1
1

1
1

1

1 1 1 1 1 1 1
9
10

11

11
12

10
1

1
1
1
L 1 1 L 1

11
12

27

11
12
11 12 27
10 11 11
11
1 L
L

10
12 12
12 13 28
9 10

13
11 11 11 11 11
11 28 11
L
.
9 10 11 12 13
28 t 9 t
36. We know that a 1 t 1 dt using simple discount. Therefore, we have
n

t 1

t 1

an a 1 t 1 dt n 12 n n 1 d
by summing the first n positive integers.

37. We have

a t

1
1
t2

,
1
.
log 2 t 2 log 2 t 1 log t 2 so that a t log 2
t 1
2
t 1

31

The Theory of Interest - Solutions Manual

Chapter 3

Now
n 1

n 1

t 0

t 0

&
a&
a 1 t log 2
n

t2
t 1

2
3
n 1
log 2 L log 2
1
2
n
n 1
2 3
log 2 L
log
2 n 1 .
n
1 2
log 2

38. The accumulated value of 1 paid at time t accumulated to time 10 is

10 1
10
r dr
20 r

t 20 r dr

t
e
e
e ln 20 r ln10
.
10
Then
10
20 r 19 18
10
s10
L 14.5.
10
10 10
10
r 1

1
1
1
1
1

4.8553
1.01 1.02 1.03 1.04 1.05
39.
B: AVB 1.04 1.03 1.02 1.01 1.00 5.1000
and taking the present value
5.1000
PVB
4.8571.
1.05
The answers differ by 4.8571 - 4.8553=.0018.
A: PVA

40. The present value of the payments in (ii) is

30a10 60v10 a10 90v 20 a10 a10 30 60v10 90v 20 .
The present value of the payments in (i) is
55a20 55a10 1 v10 .
Equating the two values we have the quadratic 90v 20 5v10 25 0. Solving the
quadratic
2
5 5 4 90 25
90
v

.5
2 90
180
10

rejecting the negative root. Now v10 .5 or

X 55a20 .0718 574.60.

1 i

41. We have the equation of value at time t 3n

98s3n 98s2 n 8000
or

32

10

2 and i .0718. Finally,

The Theory of Interest - Solutions Manual

1 i

3n

1 i

Chapter 3
2n

8000
81.6327.
i
i
98
23 1 2 2 1 10
n
We are given that 1 i 2. Therefore,

81.6327 and i .1225,

i
i
i
or 12.25%.

42. At time t 0 we have the equation of value

10, 000 4ka20 ka15 ka10 ka5
so that
10,000
k
.
4a20 a15 a10 a5
43. The present values given are:
2a2 n an 36 or 2 1 v 2 n 1 v n 36i, and
(i)

2v n an 6 or 2v n 1 v n 6i.
Thus, 2 1 v 2 n 1 v n 6 2 v n 1 v n which simplifies to the quadratic
(ii)

10v 2 n 13v n 3 0.

Solving,

2
13 13 4 10 3
6
v

.3
2 10
20
rejecting the root v n 1. Substituting back into (ii)

2 .3 1 .3 6, so that i 2 .3 .7 .07, or 7%.
i
6
n

44. An equation of value at time t 10 is

10
6
5
10, 000 1.04 K 1.05 1.04 K 1.05 1.04

K 1.04 K 1.04 10,000.

4

Thus, we have
10
10,000 1.04 1
K
1.05 1.04 6 1.05 1.04 5 1.04 4 1.04 3
$980 to the nearest dollar.
40

45. sn
n 15

s s 26
1 40
n
1 i 1 41 15

i n 15
i

using formula (3.3) twice and recognizing that there are 26 terms in the summation.

33