section 3.

Annuities

Past Exam Questions on Sections 3a to 3c

1. A man turns 40 today and wishes to provide supplemental retirement income of 3000 at the beginning
of each month starting on his 65th birthday. Starting today, he makes monthly contributions of X
to a fund for 25 years. The fund earns a nominal rate of 8% compounded monthly. Each 1000 will
provide for 9.65 of income at the beginning of each month starting on his 65th birthday until the
end of his life. Calculate X. [11/01 #27]
(A) 324.73 (B) 326.89 (C) 328.12 (D) 355.45 (E) 450.65
2. Susan and Jeff each make deposits of 100 at the end of each year for 40 years.
Starting at the end of the 41st year, Susan makes annual withdrawals of X for 15 years and Jeff makes
annual withdrawals of Y for 15 years. Both funds have a balance of 0 after the last withdrawal.
Susan’s fund earns an annual effective interest rate of 8%. Jeff’s fund earns an annual effective
interest rate of 10%.
Calculate Y − X. [SAMPLE/00 #27]
(A) 2792 (B) 2824 (C) 2859 (D) 2893 (E) 2925
3. Jeff and John shared equally in an inheritance.
Using his inheritance, John immediately bought a 10-year annuity-due with annual payments of
2500 each.
Jeff put his inheritance in an investment fund earning an annual effective interest rate of 9%. Two
years later, Jeff bought a 15-year annuity-immediate with annual payment of Z.
The present value of both annuities was determined using an annual effective interest rate of 8%.
Calculate Z. [SOA 11/96 #4]
(A) 2330 (B) 2470 (C) 2515 (D) 2565 (E) 2715
4. At time t = 0, Paul deposits P into a fund crediting interest at an effective annual interest rate of 8%.
At the end of each year in years 6 through 20, Paul withdraws an amount sufficient to purchase an
annuity-due of 100 per month for 10 years at a nominal interest rate of 12% compounded monthly.
Immediately after the withdrawal at the end of year 20, the fund value is zero.
Calculate P. [SOA 11/93 #4]
(A) 41,000 (B) 42,000 (C) 43,000 (D) 44,000 (E) 45,000
5. At an annual effective interest rate of 6.3%, an annuity immediate with 4N level annual payments
of 1,000 has a present value of 14,113.
Determine the fraction of the total present value represented by the first set of N payments and the
third set of N payments combined. [SOA 5/93 #4]
(A) 57% (B) 60% (C) 63% (D) 66% (E) 69%
6. An investment requires an initial payment of 10,000 and annual payments of 1,000 at the end of
each of the first 10 years. Starting at the end of the eleventh year, the investment returns five equal
annual payments of X.
Determine X to yield an annual effective rate of 10% over the 15-year period. [SOA 11/92 #9]
(A) 10,750 (B) 10,900 (C) 11,050 (D) 11,200 (E) 11,350
7. (This question should actually appear after Section 3i.) You are given an annuity-immediate with 11
annual payments of 100 and a final balloon payment at the end of 12 years. At an annual effective
interest rate of 3.5%, the present value at time 0 of all the payments is 1,000.

130 Copyright © 2017 ASM, 12th edition

 Past Exam Questions on Sections 3a to 3c

Using an annual effective interest rate of 1%, calculate the present value at the beginning of the
ninth year of all remaining payments. [SOA 11/89 #6]
(A) 412 (B) 419 (C) 432 (D) 439 (E) 446

8. (This question should actually appear after Section 3i.)

Kimberley is told that she can receive a 250,000 death benefit from her husband’s life insurance
in annual installments of 25,000 at the beginning of each year for 11 years and a final payment of
16,265 at the beginning of the 12th year.
Alternatively, Kimberley may receive annual installments of 13,000 at the beginning of each year
for life, with a certain period of 10 years.
Calculate the present value of a 10-year deferred life annuity-due of one per annum at Kimberley’s
issue age. [SOA 11/89 #17]
(A) 8.5 (B) 9.0 (C) 9.5 (D) 10.0 (E) 10.5

9. You are given:

(i) X is the current value at the end of year two of a 20-year annuity-due of 1 per annum.
1
(ii) The annual effective interest rate for year t is 8+t . Calculate X. [SOA 5/89 #6]
28
! 28
! 29
! 29
! 30
!
10 11 10 11 10
(A) t (B) t (C) t (D) t (E) t
t=9 t=9 t=10 t=10 t=11
a
10. Determine an expression for 5 . [SOA 11/88 #7]
a
6
a +a a +s a +s 1+a +s 1+a +s
(A) 2 3 (B) 2 3 (C) 2 3 (D) 2 2 (E) 2 2
2a 1+a +s a +s a +s 1+a +s
3 3 2 3 3 3 3 3 2

11. On January 1, an insurance company has 100,000 which is due to Linden as a life insurance death
benefit. He chooses to receive the benefit annually over a period of 15 years, with the first payment
immediately. The benefit he receives is based on an effective interest rate of 4% per annum.
The insurance company earns interest at an effective rate of 5% per annum. Every July 1, the
company pays 100 in expenses and taxes to maintain the policy.
At the end of nine years, the company has X remaining.
Calculate X. [SOA 11/88 #16]
(A) 46,000 (B) 47,100 (C) 47,700 (D) 52,800 (E) 53,900

12. John took out a 2,000,000 construction loan, disbursed to him in three installments. The first
installment of 1,000,000 is disbursed immediately and this is followed by two 500,000 installments
at six month intervals.
The interest on the loan is calculated at a rate of 15% convertible semiannually and accumulated
to the end of the second year. At that time, the loan and accumulated interest will be replaced by a
30-year mortgage at 12% convertible monthly.
The amount of the monthly mortgage payment for the first five years will be one-half of the payment
for the sixth and later years. The first monthly mortgage payment is due exactly two years after the
initial disbursement of the construction loan.
Calculate the amount of the 12th mortgage payment. [SOA 5/88 #12]
(A) 13,225 (B) 13,357 (C) 16,787 (D) 16,955 (E) 25,811

13. The proceeds from a life insurance policy are left on deposit, with interest credited at the end of each
year. The beneficiary makes withdrawals from the fund at the end of each year t, for t = 1, 2, . . . , 10.

Copyright © 2017 ASM, 12th edition 131

section 3. Annuities

At the minimum interest rate of 3% guaranteed in the policy, the equal annual withdrawal would be
1,000. However, the insurer credits interest at the rate of 4% for the first four years and 5% for the
next six years. The actual amount withdrawn at the end of year t is
Ft
Wt =
ä 11−t .03

where Ft is the amount of the fund, including interest, prior to the withdrawal.
Calculate W10. [SOA 11/87 #11]
(A) 1,160 (B) 1,167 (C) 1,172 (D) 1,177 (E) 1,183
14. Which of the following are equal to 1?
a (1+is )
(i) 10 10
1+s̈
9
(ii) v10s̈ 10 − a 9
(iii) (1 + i)10a 10 − s̈ 9
[SOA 5/87 #17]
(A) I and II only (B) I and III only (C) II and III only (D) I, II, and III
(E) The correct answer is not given by (A), (B), (C), or (D).
15. A company has a lease expiring on December 31, 1986. The company is notified that the monthly
rent will double as of January 1, 1987. This rate will be good for two years. The company wishes to
dampen the effect of the rent increase by paying a higher rent for 2 1/2 years, starting July 1, 1986.
Calculate the percentage increase on July 1, 1986 assuming an interest rate of 12% compounded
monthly. [SOA 11/86 #1]
(A) 70% (B) 72% (C) 74% (D) 76% (E) 78%
16. A person age 40 wishes to accumulate a fund for retirement by depositing an amount X at the end
of each year into an account paying 4% interest. At age 65, the person will use the entire account
balance to purchase a 15-year 5% annuity-immediate with annual payments of $10,000.
Find X. [SOA SAMPLE/84 #1]
(A) $2,490 (B) $2,520 (C) $2,550 (D) $2,580 (E) $2,610
17. At the beginning of each year for ten years $100 is deposited into a savings account.
At a simple annual interest rate of i%, the total amount in the account is $1,275 at the end of ten
years.
To the nearest $5, what would be the total amount in the account at the end of ten years if interest
had been compounded at an effective annual interest rate of i%. [CAS 11/82 #1]
(A) $1,315 (B) $1,320 (C) $1,325 (D) $1,330 (E) $1,335
18. An annuity provides a payment of $n at the end of each year for n years.
The effective annual interest rate is 1/n.
What is the present value of the annuity? [CAS 11/82 #7]
" # $n %
n
(A) n2 1 − n+1
" # $n%
n
(B) n2 1 + n+1

(C) n2 − nn+1(n + 1)−n+2

(D) n2(n + 1)−n
(E) n2 − nn+1(n + 1)−n+1

132 Copyright © 2017 ASM, 12th edition

 Solutions to Past Exam Questions on Sections 3a to 3c

Solutions to Past Exam Questions on Sections 3a to 3c

1. If you are puzzled by the statement that “Each 1000 will provide for 9.65 of income at the beginning
of each month starting on his 65th birthday until the end of his life,” you are not alone. Many students
don’t know what this means. The statement refers to what is known as a life annuity, i.e., an annuity
that is paid to someone for as long as he or she lives, rather than for a fixed or certain number of
periods. (Obviously, the PV of a life annuity depends on mortality rates as well as the interest rate.)
Life annuities are covered in later actuarial exams, so it might be considered unfair to include this
question in an FM/2 exam. However, there is actually enough information given in the question, if
properly interpreted, for an FM/2 student to answer it.
A life annuity is a product sold by life insurance companies. What the statement means is this: If
the man pays the insurance company $1,000 on his 65th birthday, the company will guarantee to
pay him $9.65 at the beginning of each month for as long as he lives. In this problem, the man wants
to receive $3,000 per month for life starting at age 65. If $1,000 would guarantee $9.65 per month,
how much does he have to pay the company to guarantee $3,000 per month?
$1,000
One way to look at this is to note that if $1,000 guarantees $9.65 per month, then 9.65 guarantees
$1.00 per month. So to guarantee $3,000 per month, we multiply this by 3,000:

Amount to be paid at age 65 to guarantee a monthly life income of $3,000

$1, 000
= 3,000 ×
9.65

AV of contributions at age 65 = X s̈ 300 at 23 %.

This must equal (3,000) $1,000

9.65 to provide a monthly income of 3,000 for life.

(3,000) $1,000
9.65 310,880.8
X= = = 324.72 ANS. (A)
s̈ 300 957.366577

2. The most convenient comparison date is the end of the 40th year.

Susan: 100s 40 = Xa 15 at 8%
25,905.65
X= = 3,026.55
8.559479
Jeff: 100s 40 = Ya 15 at 10%
44,259.26
Y= = 5,818.93
7.606080
Y − X = 2,792.38 ANS. (A)

3. The amount of John’s inheritance is equal to the PV of the annuity-due that he bought:

John’s inheritance = 2,500ä 10 .08

Since Jeff and John shared equally in the inheritance, Jeff’s share is also equal to 2,500ä 10 .08.
We are told that Jeff immediately invests his inheritance for two years at 9% effective, at which
point his investment can buy a 15-year annuity-immediate at 8% effective with an annual payment
of Z:

Copyright © 2017 ASM, 12th edition 133

section 3. Annuities

2,500ä 10 .08 (1.09)2 = Za 15 .08

21,525.07
Z= = 2,514.76 ANS. (C)
8.55948

4. Paul withdraws 100ä 120 .01 = 7,039.76 at the end of years 6 to 20. P is the PV of these withdrawals
at 8%.

P = 7,039.76v5a 15 at 8% = (7,039.76)(.6806)(8.5595)
= 41,009.68 ANS. (A)

Note: We will see in Section 3d that the PV at time 0 of payments of 7,039.76 at time 6 through
time 20 can also be expressed as 7,039.76(a 20 − a 5 ). (Imagine that there are 20 payments and then
deduct the PV of the first 5 imaginary payments.) Of course, this gives the same numerical result.
5. 14,113 = 1,000a 4N at 6.3%, 4N = 36, N = 9. The PV of the first 9 payments is 1,000a 9 = 6,713.76.
The PV of the third set of 9 payments is v186,713.76 = 2,235.46. The total PV = 14,113. Thus the
percentage of the total PV that we want is:
6,713.76 + 2,235.46
= .63 ANS. (C)
14,113

6. Use the end of the 10th year as the comparison date. The AV of the payments is:

10,000(1.1)10 + 1,000s 10 10% = 41,874.80

This must be equal to the PV of the returns:

41,874.80 = Xa 5 10%, X = 11,046 ANS. (C)

7. 1,000 = 100a 11 + Rv12 at 3.5%

1,000 − 100(9.002)
R= = 150.80
.6618
4
PV = 100a 3 .01 + 150.80v.01 = 100(2.941) + (150.80)(.961) = 439 ANS. (D)

Notes: (1) The final payment can be computed using the BA II Plus by entering 12 N 3.5 I/Y 1,000
PV 100 +/– PMT CPT FV . The result is 50.87, so final payment is 100 + 50.87 = 150.87. See
section 3h for more details.
(2) The question is a little ambiguous. The PV “at the beginning of the ninth year” could be
interpreted to include the payment of 100 due at time 8. The official SOA solution excluded this
payment.
8. (This question should actually appear after Section 3i.)
The PV of the first annuity that Kimberly could receive must be equal to the death benefit of 250,000:

250,000 = 25,000ä 11 + 16,265v11

To solve for i using the BA II Plus, put the calculater in [BGN] mode. (This is one of those
problems that make it difficult to avoid the [BGN] mode.) Then enter 11 N 250,000 PV 25,000
+/– PMT 16,265 +/– FV CPT I/Y . (These keystrokes compute the interest rate for which the PV
of 11 payments of 25,000 and a final payment of 16,265 at time 11 equals 250,000.) The result is
i = 3.0004%.

134 Copyright © 2017 ASM, 12th edition

 Solutions to Past Exam Questions on Sections 3a to 3c

Kimberly’s alternative is to receive 13,000 at the beginning of each year for 10 years certain,
followed by payments of 13,000 for life, i.e., what is called a 10-year deferred life annuity-due.
Let X = PV of a 10-year deferred life annuity-due with annual payments of 1. (This is what the
question is asking us to find.) Then we have:
# $
13,000 ä 10 + X = 250,000

250,000
X= − 8.786 = 10.5 ANS. (E)
13,000

9. From (ii) we have:

1 9+t
it = , 1 + it =
8+t 8+t
“The current value at the end of year two” of a 20-year annuity-due is the sum of the AV of the
payments at time 0, 1, and 2, and the PV of the payments at time 3, 4, . . . , 19. Since the effective
interest rate changes each year, we write the current value as follows:
& '& ' & '
X = 1 + i1 1 + i2 + 1 + i2 + 1
1 1 1
+ +& '& ' +...+ & ' & '
1 + i3 1 + i3 1 + i4 1 + i3 . . . 1 + i19
( )( ) ( )( )
10 11 11 11 11 12
= + + 1+ +
9 10 10 12 12 13
( )( ) ( )
11 12 . . . 27
+...+
12 13 28
11 11 11 11 11 . . . 11
= + + + + + +
9 10 11 12 13 28
*28
11
= ANS. (B)
t=9
t

10. To get the format of the answer choices, express the ratio as follows:

a5 a 3 + v3a 2
=
a6 a 3 + v3a 3

Multiplying numerator and denominator by (1 + i)3:

a5 (1 + i)3a 3 + a 2
=
a6 (1 + i)3a 3 + a 3
s3 + a2
= ANS. (C)
s3 + a3

100,000 100,000
11. Annual benefit = ä = 11.563 = 8,648.27
15 .04

1
X = 100,000(1.05)9 − 8,648.27s̈ 9 .05 − 100s̈ 9 .05v.05
2

= 100,000(1.5513) − 11.578[8,648.27 + (100)(.9759)] = 53,870 ANS. (E)

Copyright © 2017 ASM, 12th edition 135

section 3. Annuities

12. If x = monthly mortgage payment in the first 5 years, we have (using the end of the 2nd year as the
comparison date):
# $
x 2ä 360 .01 − ä 60 .01 = 1,000,000(1.075)4
# $
+ 500,000 1.0753 + 1.0752 = 2,534,430

2,534,430 2,534,430
x= = = 16,787 ANS. (C)
2ä 360 − ä 60 (2)(98.190514) − 45.404589

13. F0 = 1,000a 10 .03 , F1 = 1,000a 10 .03(1.04)

( )
1,000a 10 .03(1.04) 1.04
W1 = = 1,000
ä 10 .03 1.03
( )
& ' 1.04 " %
F2 = F1 − W1 1.04 = 1,000 a 10 (1.03) − 1 (1.04)
1.03
( )
1.04
= 1,000a 9 .03 (1.04)
1.03
( )2
F2 1.04
W2 = = 1,000
ä 9 .03 1.03

1,000(1.04)4(1.05)6 1,000(1.1699)(1.3401)
Similarly, W10 = =
1.0310 1.3439
= 1,166.59 ANS. (B)
Note: This is a tough problem under exam conditions. It might be smart to skip it and spend time
on questions that you would be more likely to succeed in doing.
14. (i) Numerator: a 10 (1 + is 10 ) = a 10 [1 + (1 + i)10 − 1] = s 10
Denominator: 1 + s̈ 9 = s 10
Thus (i) = 1

(ii)v10s̈ 10 − a 9 = ä 10 − a 9 = 1 + a 9 − a 9
Thus (ii) = 1

(iii)(1 + i)10a 10 − s̈ 9 = s 10 − s̈ 9 = s 10 − (s 10 − 1)
Thus (iii) = 1

15. Let x = monthly rent as originally scheduled for 1986, kx = rent effective 7/1/86 under the revised
schedule. Using 7/1/86 as the comparison date:

kx ä 30 = x ä 6 + 2xv6ä 24 at 1%

a 6 + 2v6a 24 5.795 + 2(.9420)(21.243)

k= =
a 30 25.808
= 1.775, i.e., increase of 77.5% ANS. (E)

103,796.58
16. Xs 25 .04 = 10,000a 15 .05 , X= 41.646 = 2,492 ANS. (A)

136 Copyright © 2017 ASM, 12th edition

 Solutions to Past Exam Questions on Sections 3a to 3c

17. At simple interest rate i%, the AV of the 10 deposits is:

+( ) ( ) ( ),
i 2i 10i
100 1 + + 1+ + . . . + 1+ = 1,275
100 100 100
( )
55i
100 10 + = 1,275
100
275
i= =5
55
At compound interest effective rate 5%:

AV = 100s̈ 10 .05 = 1,320.68 ANS. (B)

n+1 n
18. i = n1 , 1 + i = n , v= n+1

1
PV = na n at rate i =
n
" # $n%
( n
) 1 − n
1− v n+1
=n =n 1
i n
+ ( )n ,
n
= n2 1 − ANS. (A)
n+1

Copyright © 2017 ASM, 12th edition 137