The Infinite Actuary’s

Joint Exam 2/FM

Sample Exam 3

by James Washer, FSA, MAAA

last update - June 14, 2013

Take this sample exam under strict exam conditions. Start a timer for 3 hours and stop immediately
when the timer is done. Do not stop the clock when you go to the bathroom. Do not look at your notes.
Do not look at the answer key.

This exam contains 35 questions. Do not spend too much time on any one question. Choose the best
available answer for each question.

This exam contains 25 questions from the May 2005 FM exam plus 10 original questions scattered
throughout. If you have already worked the May 2005 exam, then you can just work the original
problems: 3, 6, 7, 10, 13, 16, 19, 23, 28 and 35.
1. Which of the following expressions does NOT represent a definition for an ?

(1 + i)n − 1
 
A. v n
i
1 − vn
B.
i
C. v + v 2 + · · · + v n
1 − vn
 
D. v
1−v
sn
E.
(1 + i)n−1

2. Lori borrows 10,000 for 10 years at an annual effective interest rate of 9%. At the end of each year, she
pays the interest on the loan and deposits the level amount necessary to repay the principal to a sinking
fund earning an annual effective interest rate of 8%.

The total payments made by Lori over the 10-year period is X.

Calculate X.

A. 15,803 B. 15,853 C. 15,903 D. 15,953 E. 16,003

3. Ashton wants to create an asymmetric butterfly on Stock XYZ with put options at strikes of 90, 100
and 105. The current stock price is 100 and the stock does not pay dividends. The following options
are available:

Strike Call Put

90 13.38 1.55
95 9.85 2.92
100 6.95 4.92
105 4.70 7.56
110 3.05 10.81

He will purchase 3 put options with a strike of 90. Find the total premium Ashton will pay or receive.

A. pay 2.19 B. receive 2.19 C. pay 5.73 D. receive 5.73 E. Not enough information.

4. A bond will pay a coupon of 100 at the end of each of the next three years and will pay the face value of
1000 at the end of the three-year period. The bond’s duration (Macaulay duration) when valued using
an annual effective interest rate of 20% is X.

Calculate X.

A. 2.61 B. 2.70 C. 2.77 D. 2.89 E. 3.00

5. An estate provides a perpetuity with payments of X at the end of each year. Seth, Susan, and Lori
share the perpetuity such that Seth receives the payments of X for the first n years and Susan receives
the payments of X for the next m years, after which Lori receives all the remaining payments of X.

Which of the following represents the difference between the present value of Seth’s and Susan’s payments
using a constant rate of interest?

A. X [an − v n am ]
B. X [än − v n äm ]
C. X an − v n+1 am
 

D. X an − v n−1 am
 

E. X an − v n+1 am
 

6. Alexander creates a collared stock position by:

(i) buying a share of stock for 100

(ii) creating a one-year 95-105 collar as insurance against declines using two options from the following
table of one-year options:

Strike Price Call Premium Put Premium

95 16.90 4.33
100 14.04 6.07
105 11.54 8.17

The risk-free rate is 8% compounded continuously. Calculate Alexander’s total profit if the spot price
at expiration is 90.

A. −5.52 B. −5.21 C. −3.74 D. −2.81 E. −2.50

7. Which of these positions will benefit from an increase in the price of the underlying assets?

1. long call

2. long put

3. short call

4. short put

A. 1, 2 B. 3, 4 C. 1, 4 D. 2, 3
E. The correct answer not given by (A), (B), (C) or (D).
8. Susan can buy a zero coupon bond that will pay 1000 at the end of 12 years and is currently selling for
624.60 . Instead she purchases a 6% bond with coupons payable semi-annually that will pay 1000 at the
end of 10 years. If she pays X she will earn the same annual effective interest rate as the zero coupon
bond.

Calculate X.

A. 1164 B. 1167 C. 1170 D. 1173 E. 1176

9. John purchased three bonds to form a portfolio as follows:

• Bond A has semi-annual coupons at 4%, a duration of 21.46 years, and was purchased for 980.

• Bond B is a 15-year bond with a duration of 12.35 years and was purchased for 1015.

• Bond C has a duration of 16.67 years and was purchased for 1000.

Calculate the duration of the portfolio at the time of purchase.

A. 16.62 years B. 16.67 years C. 16.72 years D. 16.77 years E. 16.82 years

10. On March 3, 2011, at 1:00 PM EST, the stock price of Apple (AAPL) is $360. You are given the
following option prices for a strike of $350:

Type Price
Call $30.50
Put $13.40

Five minutes later, Steve Jobs announces the iPad 2. The new option prices are (same strike of $350):

Type Price
Call $35.25
Put $11.15

Assuming AAPL never pays dividends, calculate the new price of Apple stock immediately following
the iPad 2 announcement.

A. $363 B. $364 C. $365 D. $366 E. $367

11. Mike receives cash flows of 100 today, 200 in one year, and 100 in two years. The present value of these
cash flows is 364.46 at an annual effective rate of interest i.

Calculate i.

A. 10% B. 11% C. 12% D. 13% E. 14%

12. A loan is being repaid with 25 annual payments of 300 each. With the 10th payment, the borrower pays
an extra 1000, and then repays the balance over 10 years with a revised annual payment. The effective
rate of interest is 8%.

Calculate the amount of the revised annual payment.

A. 157 B. 183 C. 234 D. 257 E. 383

13. Which of the following are reasons an investor might short-sell?

1. Speculation

2. Financing

3. Hedging

A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3

E. The correct answer not given by (A), (B), (C) or (D)

14. The present value of a series of 50 payments starting at 100 at the end of the first year and increasing
by 1 each year thereafter is equal to X. The annual effective rate of interest is 9%.

Calculate X.

A. 1165 B. 1180 C. 1195 D. 1210 E. 1225

15. Yield rates to maturity for zero coupon bonds are currently quoted at 8.5% for one-year maturity, 9.5%
for two-year maturity, and 10.5% for three-year maturity. Let i be the one-year forward rate for year
two implied by current yields of these bonds.

Calculate i.

A. 8.5% B. 9.5% C. 10.5% D. 11.5% E. 12.5%

16. Today the LIBOR spot rates are:

Years to Maturity Spot Rate

1 4.50%
2 5.00%
3 5.75%
4 6.75%
5 8.00%

Today you enter into a 5-year interest rate swap (with a notional amount of 100,000) to pay a fixed rate
and to receive a floating rate based on future 1-year LIBOR rates. If the swap has annual payments,
what is the fixed rate you should pay?

A. 7.68% B. 7.78% C. 7.88% D. 7.98% E. 8.08%

17. A 1000 par value bond pays annual coupons of 80. The bond is redeemable at par in 30 years, but is
callable any time from the end of the 10th year at 1050.

Based on her desired yield rate, an investor calculates the following potential purchase prices, P :

• Assuming the bond is called at the end of the 10th year, P = 957

• Assuming the bond is held until maturity, P = 897

The investor buys the bond at the highest price that guarantees she will receive at least her desired
yield rate regardless of when the bond is called.

The investor holds the bond for 20 years, after which time the bond is called.

Calculate the annual yield rate the investor earns.

A. 8.56% B. 9.00% C. 9.24% D. 9.53% E. 9.99%

18. Which of the following are characteristics of all perpetuities?

I. The present value is equal to the first payment divided by the annual effective interest rate.

II. Payments continue forever.

III. Each payment is equal to the interest earned on the principal.

A. I only B. II only C. III only D. I, II, and III

E. The correct answer is not given by (A), (B), (C), or (D).

19. An annuity-immediate has annual payments of $7000, $5000 and $3000.

Determine the convexity of the annuity at i = 5%.

A. 4.7 B. 4.8 C. 4.9 D. 5.0 E. 5.1

20. At a nominal interest rate of i convertible semi-annually, an investment of 1000 immediately and 1500
at the end of the first year will accumulate to 2600 at the end of the second year.

Calculate i.

A. 2.75% B. 2.77% C. 2.79% D. 2.81% E. 2.83%

21. An annuity-immediate pays 20 per year for 10 years, then decreases by 1 per year for 19 years. At an
annual effective interest rate of 6%, the present value is equal to X.

Calculate X.

A. 200 B. 205 C. 210 D. 215 E. 220

22. An insurance company accepts an obligation to pay 10,000 at the end of each year for 2 years. The
insurance company purchases a combination of the following two bonds at a total cost of X in order to
exactly match its obligation:

(i) 1-year 4% annual coupon bond with a yield rate of 5%.

(ii) 2-year 6% annual coupon bond with a yield rate of 5%

Calculate X.

A. 18,564 B. 18,574 C. 18,584 D. 18,594 E. 18,604

23. You are given the following information:

(i) The current price of Stock ABC is X.

(ii) Stock ABC pays dividends at a continuous rate of 5% per annum.

(iii) A 2-year prepaid forward contract price on Stock ABC is 105.

(iv) The risk-free rate is 7% per annum.

Determine X.

A. 100.88 B. 110.38 C. 112.61 D. 116.04 E. 120.78

24. At the beginning of the year, an investment fund was established with an initial deposit of 1000. A new
deposit of 1000 was made at the end of 4 months. Withdrawals of 200 and 500 were made at the end of
6 months and 8 months, respectively. The amount in the fund at the end of the year is 1560.

Calculate the dollar-weighted (money-weighted) yield rate earned by the fund during the year.

A. 18.57% B. 20.00% C. 22.61% D. 26.00% E. 28.89%

25. At an annual effective interest rate of i, the present value of a perpetuity-immediate starting with a
payment of 200 in the first year and increasing by 50 each year thereafter is 46,530.

Calculate i.

A. 3.25% B. 3.50% C. 3.75% D. 4.00% E. 4.25%

26. A store is running a promotion during which customers have two options for payment. Option one is to
pay 90% of the purchase price two months after the date of sale. Option two is to deduct X% off the
purchase price and pay cash on the date of sale.

A customer wishes to determine X such that he is indifferent between the two options when valuing
them using an effective annual interest rate of 8%.

Which of the following equations of value would the customer need to solve?
X 0.08



A. 100 1+ 6 = 0.90
X
1 + 0.08



B. 1 − 100 6 = 0.90
X
(1.08)1/6 = 0.90


C. 100
X

1.08

D. 100 1.06 = 0.90
X
(1.08)1/6 = 0.90


E. 1 − 100

27. Calculate the nominal rate of discount convertible monthly that is equivalent to a nominal rate of interest
of 18.9% per year convertible monthly.

A. 18.0% B. 18.3% C. 18.6% D. 18.9% E. 19.2%

28. You are given the following information regarding widgets:

(i) The current price of a widget is 15.25.

(ii) The one year forward price is 16.00.

(iii) It takes one year and 14.00 to create a widget.

You are given the following information regarding a widget maker:

(i) During the next year he will make 2000 widgets and sell them exactly one year from now at the
market price.

(ii) He buys 2000 options to create a floor price on widgets of 15.00.

Assume the following:

(i) The risk-free rate is 5% per annum.

(ii) The cost of creating a widget is incurred halfway through the year.

(iii) One year widget option prices with a strike of 15.00 are 1.20 and 0.22 for call and put options
respectively.

Calculate the minimum economic profit the widget maker will earn?

A. 806.23 B. 846.54 C. 1019.41 D. 1192.27 E. 1365.14

29. An investor wishes to accumulate 10,000 at the end of 10 years by making level deposits at the beginning
of each year. The deposits earn a 12% annual effective rate of interest paid at the end of each year. The
interest is immediately reinvested at an annual effective interest rate of 8%.

Calculate the level deposit.

A. 541 B. 572 C. 598 D. 615 E. 621

30. A discount electronics store advertises the following financing arrangement:

“We don’t offer you confusing interest rates. We’ll just divide your total cost by 10 and you can pay us
that amount each month for a year.”

The first payment is due on the date of sale and the remaining eleven payments at monthly intervals
thereafter.

Calculate the effective annual interest rate the store’s customers are paying on their loans.

A. 35.1% B. 41.3% C. 42.0% D. 51.2% E. 54.9%

31. On January 1, 2004, Karen sold stock A short for 50 with a margin requirement of 80%. The proceeds
of the short sales are held by the lender and Karen does not earn any interest on the proceeds.

On December 31, 2004, the stock paid a dividend of 2, and an interest amount of 4 was credited to the
margin account. On January 1, 2005, Karen covered the short sale at a price of X, earning a 20% return
on her investment.

Calculate X.

A. 40 B. 44 C. 48 D. 52 E. 56

32. The stock of Company X sells for 75 per share assuming an annual effective interest rate of i. Annual
dividends will be paid at the end of each year forever.

The first dividend is 6, with each subsequent dividend 3% greater than the previous year’s dividend.

Calculate i.

A. 8% B. 9% C. 10% D. 11% E. 12%

33. An annuity pays 1 at the end of each year for n years. Using an annual effective interest rate of i, the
accumulated value of the annuity at time (n + 1) is 13.776 . It is also known that (1 + i)n = 2.476.

Calculate n.

A. 4 B. 5 C. 6 D. 7 E. 8
34. A bank customer takes out a loan of 500 with a 16% nominal interest rate convertible quarterly. The
customer makes payments of 20 at the end of each quarter.

Calculate the amount of principal in the fourth payment.

A. 0.0 B. 0.9 C. 2.7 D. 5.2

E. There is not enough information to calculate the amount of principle.

35. You are given:

(i) A bank has a liability of 5000 to be paid in 4.5 years.

(ii) The following zero coupon bonds are available:

Years Yield
4 5%
5 5%

(iii) The bank wants to immunize itself from small changes in interest rates on either side of 5% using
Redington immunization.

Calculate the amount the bank should invest in the 5-year bond.

A. 2007.18 B. 2175.80 C. 2428.21 D. 2561.74

E. Redingtion immunization is not possible for this scenario.