Financial Mathematics

J2FIN: Problem Sheet 4 Solution

Dr Jia Shao

Financial Mathematics 2024

1. If we work in months, the relevant interest rate i = 7%/12 per month

effective.

(a) The schedule is as follows:

(b) In the last month (month 180), after the final monthly mortgage
payment is made, the ending mortgage balance will be zero. That is,
the mortgage will be fully paid.

2. (a) Let X be the initial annual repayment. The equation of value is

16, 000 = X a 10 at 8%

from which we obtain X = £2, 384.46.

(b) The loan outstanding just after the fourth payment is made is

2, 384.46a 6 at 8% = 11, 023.14

Let Y be the revised annual installment. The equation of value is

Y a 6 = 11, 023.14 at 10%

which gives Y = £2, 530.99.

(c) The loan outstanding just after the seventh payment is made is

2, 530.99a 3 at 10% = 6, 294.32

Let Z be the revised annual installment; the equation of value is

Z a 3 = 6, 294.32 at 9%

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and so Z = £2, 486.60.

The equation of value for the entire transaction is

16, 000 = 2, 384.46a 4 + 2, 530.994| a 3 + 2, 486.607| a 3

By interpolation between 8% and 9%, the yield, or effective rate of

interest, per annum is 8.60%.

3. (a) (i) Let X be the annual repayment. The amount lent is the present
value, on the stated interest basis, of the repayments.
Therefore, h i
6
X a 6 0.10 + v0.10 · a 12 0.09 = 2, 000

from which we obtain X = £238.17.

(ii) The loan outstanding just after payment of the third payment is

2, 000(1.1)3 − 238.17s 3 0.10 = 1, 873.65

The loan outstanding just after payment of the fourth payment is

2000(1.1)4 − 238.17s 4 0.10 = 1, 822.84

The capital repaid at time t = 4 is therefore

1, 873.65 − 1, 822.84 = £50.81

The loan outstanding just after payment of the 11 th payment is

238.17a 7 at 9% = 1, 198.71

The loan outstanding just after payment of the 12 th payment is

238.17a 6 at 9% = 1, 068.42

Hence, the capital repaid at time t = 12 years is

1198.71 − 1068.42 = £130.29

(b) After the special payment, the capital outstanding is £968.42.

The revised annual repayment, Y , is found from the equation of value

Y a 6 0.09 = 968.42

which gives
Y = £215.88

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4. The total cash payable is

Z n
1 2
t dt = n
0 2

We find n from the equation

¯ n = 1 2
(Iā) n at 5%
4
i.e.,
ā n − nv n 1
= n2
δ 4
i.e.,
1 − vn 1
− nv n − δn2 = 0 at 5%
δ 4
By trials and interpolation, we find that n = 22.37.
5. (a) Let X be the initial quarterly payment. We have the equation of
value
(4) (4) (4)
4X a 15 + 1605| a 10 + 16010| a 5 = 11, 820 at 12%

This gives X = 389.96.

(b) (i) The initial annual amount of the annuity is 4X, i.e., £1, 559.84.
The loan outstanding just after payment of the eighth installment
(at the end of the second year) is
(4)
11, 820(1 + i)2 − 1, 559.84s 2 at 12% = 11, 374.85

and, just after the 12 th installment is paid, the loan outstanding is

(4)
11, 820(1 + i)3 − 1, 559.84s 3 at 12% = 11, 111.45

The capital repaid during the third year of the loan is therefore

11, 374.85 − 11, 111.45 = £263.40

(ii) In the final 5 years it is easier to calculate the outstanding loan

by valuing the future annuity installments than by accumulating the
original loan less past installments of the annuity. Therefore, we
obtain the expressions
(4)
1, 879.84a 3 at 12%
(4)
1, 879.84a 2 at 12%

for the loan outstanding at the end of the 12 th and 13 th years,

respectively (after payment of the annuity installments due at these

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times). The capital repaid in the 13 th year is then

 
(4) (4)
1, 879.84 a 3 − a 2 at 12% = £1, 369.82

(c) The loan outstanding just after the 33rd installment is paid is (on
valuing future payments)
(4) (4)
1, 879.84a 6.75 − 160a 1.75 at 12% = 8, 493.09

Let the revised quarterly annuity payment be Y . We have the equa-

tion of value
(4)
4Y a 6.75 = 8, 493.09 at 12%

which gives Y = 456.50.

6. (a) (i) Let the annual repayment be X. We have

X a 25 = 3, 000 at 12%

So
300
X= = £382.50
a 25

(ii) (1) Note: this solution is correct, as it is asking for the payment
that you made at the 9th year (1 payment), what are the capital and
interest you paid respectively.
The loan outstanding just after the payment at time 9 years is

382.50a 16 = 2, 667.56

and just after the payment at time 10 years it is

382.50a 15 = 2, 605.17

Hence, the capital repaid at the end of the tenth year is

2, 667.56 − 2, 605.17 = £62.39

and the interest paid at this time is

382.50 − 62.39 = £320.11

(2) The capital outstanding just after the payment at time 24 years
is
382.50a 1 = £341.52

The capital repaid at the end of the 25th year is therefore £341.52,

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and the interest paid at this time is

382.50 − 341.52 = £40.98

(iii) The loan outstanding after the t th repayment is 382.50a 25−t .

This first falls below 1,800 when a 25−t (at 12% ) first falls below
4.7059. By the compound interest tables, the smallest value of t for
which a 25−t < 4.7059 is 18 , so the answer is the 18th repayment.
(iv) Using the loan schedule, the capital content exceeds the interest
content of the t th installment when

1 − v 26−t < v 26−t

i.e., when
v 26−t > 0.5

This first occurs when t = 20, i.e., for the 20th payment.
(b) The loan outstanding just after the 15th annual payment has been
made is
382.50a 10 at 12% = 2, 161.20

Let Y be the revised annual payment. The equation of value is

Y a 16 = 2, 161.20 at 12%

which gives Y = £309.89.

7. (a) Let X/12 be the monthly repayment. We solve the equation of value
(12)
X a 25 = 9, 880 at 7%

to obtain X = 821.76. Hence, the monthly repayment is £68.48.

(12)
(b) The loan outstanding is X a at 7% = £6, 486.
34/3
(c) The loan outstanding just after the repayment on 10 September 2009
(12)
is made is X a at 7%.
83/6
The loan outstanding just after the repayment on 10 October 2009
(12)
is made is X a 13.75 at 7%.
The capital repaid on 10 October 2009 is therefore
 
(12) (12)
X a − a 13.75 at 7%
83/6
 13.75
− v 83/6

v
=X at 7% = £26.86
i(12)

(d) (i) The capital repayment contained in these 12 installments is

 
(12) (12)
X a −a at 7% = £516.20
22/3 19/3

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(ii) The total interest in these 12 installments is [by (i)]

X − 516.20 = £305.56

(e) The capital and interest contents of each installment may be found
(12)
by means of the loan schedule, using the rate of interest j = i0.07 /12
per month. The capital and interest contents of the tth repayment
are therefore
9, 880 301−t
v at rate j
a 300
and
9, 880
1 − v 301−t at rate j


a 300
respectively. Note that j = 0.005654. We therefore require the small-
est t such that
1
v 301−t > 1 − v 301−t at rate j


2
i.e.,
(1 + j)301
(1 − j)t > at rate j
3
i.e.,
− ln 3 + 301 ln(1 + j)
t> = 106.15
ln(1 + j)
The required value of t is then 107 . The capital repaid first exceeds
one-half of the interest content at the 107 th installment, payable on
10 June 2017. (The capital content of this installment is £22.94, and
the interest content is £45.54.)

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