MATH2P75

Assignment 1

Dr. Pauline Fu

Assignment 1 (5%)
Due June 11 28 by 7:00 PM
Introductory Financial Mathematics
MATH 2P75, Spring 2014
Department of Mathematics and Statistics
Brock University
Objectives (week 1 to week 4)

Calculate interest, maturity value (future value), and present value in both

simple interest and compound interest environments.

Calculate the equivalent value on any date of a single payment or a

stream of payments.
Compute present value for treasury bills.
Compute interest and balances for demand loans and lines of credit.
Construct repayment schedules for loans.
Calculate the income yield, capital gain yield, and rate of total return on
stocks and mutual funds.

Solving the following problems. Show all your work in details.

Put double lines for your answers. Include a cover page showing
your name, student number, email, course name and course
code, assignment number, your instructors name, and the date
of submission.
1. An assignable loan contract executed 3 months ago requires two
payments of $3200 plus interest at 9% from the date of the contract, to
be paid 4 and 8 months after the contract date. The payee is offering to
sell the contract to a finance company in order to raise urgently
needed cash. If the finance company requires a 16% rate of return,
what price will it be prepared to pay today for the contract?

4
1 0.09 12

= $3296.00
Size of first payment = $3200

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Assignment 1

Dr. Pauline Fu

8
1 0.09 12

= $3392.00
Size of second payment = $3200
$3296.00
$3392.00
1
5
1 0.16 12
1 0.16 12
Sum of the present values of the two payments =
+
= $3252.63 + $3180.00
= $6432.63

The finance company should be prepared to pay $6432.63 today for the loan contract

2 A $100,000, 168-day Government of Canada Treasury bill was

purchased on its date of issue to yield 3.7%
a. What price did the investor pay?
b. Calculate the market value of the T-bill 85 days later if the
annual rate of return then required by the market has
i. Risen to 4.0%
ii. Remained at 3.7%
iii. Fallen to 3.4%
c. Calculate the rate of return actually realized by the investor if
the T-bills is sold at each of the three prices calculated in Part
(b).

a.

Price =
b.

$100,000
1 0.037 168
365

= $98,325.50

Market
return
(i)

(ii)

(iii)

c.

Market
value

4%

$100,000
83
1 0.04 365

= $99,098.61

3.7%

$100,000
83
1 0.037 365

= $99,165.65

3.4%

$100,000
83
1 0.034 365

= $99,232.78

The interest effectively earned in each case was:

(i)
I = S P = $99,098.61 $98,325.50 = $773.11
(ii)
I = S P = $99,165.65 $98,325.50 = $840.15
(iii)
I = S P = $99,232.78 $98,325.50 = $907.28
The rate of return actually realized in each case was:
$773.11
I
85
$98,325.50 365
(i)
r = Pt =
= 0.03376 = 3.376%

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(ii)
(iii)

Dr. Pauline Fu

r=

$840.15
85
$98,325.50 365

= 0.03669 = 3.669%

r=

$907.28
85
$98,325.50 365

= 0.03962 = 3.962%

3.Suppose that the current rates on 60- and 120-day GIC are 5.5% and
5.75% respectively. An investor is weighing the alternatives of
purchasing a 120-day GIC versus purchasing a 60-day GIC and then
reinvest its maturity value in a second 60-day GIC. What would the
interest rate on 60-day GICs have to be 60 days from now for the investor
to end up in the same financial position with either alternative?
Suppose that the amount invested is $1000. Its maturity value in a 120-day GIC will be

120
1 0.0575 365

= $1018.90
$1000
If instead, the $1000 is invested in a 60-day GIC,

60
1 0.055 365

=$1009.04
Maturity value = $1000
For this amount to grow to $1018.90 in another 60 days, it must earn
Interest = $1018.90 $1009.04 = $9.86
The interest rate on the second 60-day GIC would have to be
$9.86
I
60
$1009.04 365
r = Pt =
= 0.05944 = 5.944%

4. George borrowed $4000 on demand from CIBC on January 28 for an

RRSP contribution. Because he used the loan proceeds to purchase
CIBCs mutual funds for his RRSP, the interest rate on the loan was
set on the banks prime rate. George agreed to make monthly
payments of $600 (except for a smaller final payment) on the twentyfirst of each month, beginning February 21. The prime rate was
initially 6.75%, dropped to 6.5% effective May 15, and decreased
another 0.25% on July 5. It was not a leap year. Construct a repayment
schedule showing the amount of each payment and the allocation of
each payment to interest and principal.
Date
28-Jan
21-Feb
21-Mar
21-Apr

Number
of days
-24
28
31

Interest
rate
-6.75%
6.75
6.75

Interest
-$17.75
17.70
16.26

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Accrued
interest
-$17.75
17.70
16.26

Payment
(Advance)
-$600.00
600.00
600.00

Principal
portion
-$582.25
582.30
583.74

Balance
$4000.00
3417.75
2835.45
2251.71

MATH2P75
15-May
21-May
21-Jun
5-Jul
21-Jul
21-Aug

Assignment 1
24
6
31
14
16
31

6.75
6.50
6.50
6.50
6.25
6.25

9.99
2.41
9.19
2.68
2.94
2.54

9.99
12.40
9.19
2.68
5.62
2.54

Dr. Pauline Fu

600.00
600.00

587.60
590.81

600.00
481.46

594.38
478.92

2251.71
1664.11
1073.30
1073.30
478.92
0.00

Note: the stroke indicates that the interest has been paid.

5. Julia borrowed $3000, $3500, and $4000 from her grandmother on

December 1 in each of three successive years at college. They agreed
that interest would accumulate at the rate of 4% compounded
semiannually. Julia is to start repaying the loan on June 1 following
the third loan. What consolidated amount will she owe at that time?
Amount owed on June 1 (following graduation)
5
3
= $3000 1.02 + $3500 1.02 + $4000(1.02)
= $3312.24 + $3714.23 + $4080.00
= $11,106.47

6. If the total interest earned on an investment at 6.6% compounded

monthly for three and half years was $1683.90, what was the original
investment?
Let x represent the original investment. Its maturity value was
n
42
x 1 i = x 1.0055
x 1.0055
x = $1683.90
1.2590621x x = $1683.90
x = $6499.99
The original investment was $6499.99.
Hence,

42

7. A furniture store is advertising television sets for 25% down and no

interest on the balance, which is payable in a lump amount six months
after the date of sale. When asked what discount would be given for
cash payment on an $1195 set, the salesclerk offered $30. If you can
earn 5% compounded monthly on short-term funds, should you pay
cash and take the discount, or purchase the set on the advertised
terms?
Allowing for the ability of money to earn 5% compounded monthly, today's
economic value of the 25%-down, 75%-in-6-months payment plan
is

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Assignment 1

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0.25($1195) + 0.75($1195) 1.0041 6

= $1172.92
The discounted price is $1165. You should choose the lower
economic
value alternative. Therefore, pay cash and take the discount.

8. A five-year, compound-interest GIC purchased for $1000 earns 6%

compounded annually. How much interest will the GIC earn in the
fifth year?
Accumulated value of the GIC after 4 years
4
4
= PV 1 i = $1000 1.06 = $1262.48
Interest earned in fifth year = 0.06($1262.48) = $75.75

9. A $1000 face value strip bond has 19 years remaining until maturity.
What is its price if the market rate of return on such bonds is 5.9%
compounded semi-annually? At this market rate of return, what will
be the increase in the value of the strip bound during the fifth year of
ownership?
Current price:
PV = FV 1 i
1.0295 28

Price in 4 years:
PV = $1000 1.0295

38
= $1000 1.0295
= $331.28

= $418.03

Price in 5 years:
30

PV = $1000

= $443.06

10.A loan contract called for a payment after two years of $1500 plus
interest (on this $1500) at 8% compounded quarterly, and a second
payment after four years of $2500 plus interest (on this $2500) at 8%
compounded quarterly. What would you pay to purchase the contract
18 months after the contract date if you require a return of 10.5%
compounded semiannually?
Payment due in 2 yr.:
Payment due in 4 yr.:
8
16
FV = $1500 1.02 = $1757.49
FV = $2500 1.02 = $3431.96
The fair market value of the note, 18 months after the issue date, is the
present value on the date of sale of the scheduled payments. That is,
1
5
Price = $1757.49 1.0525 + $3431.96 1.0525
= $1669.82 + $2657.25 =
$4327.07

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Assignment 1

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11.A portfolio earned -13%, 18%, 5%, 24%, and -5% in five successive
years. What was the portfolios five-year compound annual return?

The value, after 5 years, of an initial $100 investment was

FV PV 1 i1 1 i5
= $100(1 0.13)(1 + 0.18)(1 + 0.05)(1 + 0.24)(1 0.05)
= $126.98
The 5-year compound annual return was
FV
i

PV

1
n

$126.98

= $100
= 0.0489
= 4.89%

1
5

12.Terry was supposed to pay $800 to Becky on March 1. At a later date,

Terry paid Becky an equivalent payment in the amount of $895.67. If
they provided for a time value of money of 8% compounded monthly,
on what date did Terry make the payment?

FV
$895.67
ln

PV
$800

n
ln 1+ i = ln 1.00 6
.
0.11296
= 0.0066445
= 17.00 periods
Terry made the payment 17 months after March 1,
that is, on August 1 of the following year.
ln

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