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Week 2 Sols

The document is a workshop guide for financial mathematics, covering concepts such as simple and compound interest, and providing exercises with solutions. It includes examples of calculating interest rates, future values, and present values in various financial scenarios. The guide emphasizes the application of financial principles learned in lectures.

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6 views

Week 2 Sols

The document is a workshop guide for financial mathematics, covering concepts such as simple and compound interest, and providing exercises with solutions. It includes examples of calculating interest rates, future values, and present values in various financial scenarios. The guide emphasizes the application of financial principles learned in lectures.

Uploaded by

allieyahei
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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BFC5926

MONASH
BUSINESS
SCHOOL

We have discussed the principles of financial


maths in Topic 2 lecture.
BFC5926
Financial Institutions and Markets
Now it is your turn to apply the concepts in the
following exercises:
Workshop 2 Financial maths
Questions & Solutions

Question 1 Solution 1
Explain the difference between simple and SIMPLE INTEREST: the calculation of interest is
compound interest? based on the initial principal amount invested
or borrowed. For example, funds invested in a
bank term deposit for six-months where
simple interest is paid monthly. The investor
will receive the interest payment each month
by cash and the amount invested in the term
deposit will remain the same. The principal
will be repaid at maturity.
•
3 4

Solution 1 Cont. Solution 1 Cont.


COMPOUND INTEREST: compounding refers to For example, an original investment of $1000 earns
the situation where interest earned in one 10% p.a. compounding annually. At the end of the
period is added to the principal. Interest in first year the interest earned is 10% of $1000 = $100.
The $100 interest is added to the original principal
the next period is then earned on the larger amount. During the second year interest is earned
total amount (principal plus interest) and is on the new accumulated principal amount of $1100.
also added to the total amount at the end of Interest earned is 10% of $1100 = $110. The $110 is
the next period. then added to the existing $1100 to give a new
balance of $1210. And so the process proceeds until
maturity.
•
5 6

1
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Question 2 Solution 2
Find the interest rate, or rates of return, on (a) & (b) PV=$700, interest payment over one
each of the following: year $49, FV=$749 find i; i= 7%
a) You borrow $700 and promise to pay back (c) PV=$9,000, ordinary annuity of $2,684.80
$749 at the end of 1 year. for 5 years; find i; i= 15%
b) You lend $700 and receive a promise to be
paid $749 at the end of 1 year.
c) You borrow $9,000 and promise to make
payments of $2,684.80 per year for 5
years.
7 8

Question 3 Solution 3
Jean invested her lottery prize of $80 000 in a Use equation 8 form the formula sheet:
fund which pays 6 per cent per annum.
How much will she have at the end of 8 years? 𝐹𝑉 = 𝑃𝑉(1 + 𝑖)
𝐹𝑉 = 80000(1 + 0.06)
𝐹𝑉 = $127,507.84

9 10

Question 4 Solution 4
If Sootico borrowed $500 000 now at 6 per Using Equation 10 :
cent (per annum) compounding monthly, how 1 − (1 + 𝑘)
much must it repay monthly to pay off the 𝑃𝑉𝐴 = 𝐶
𝑘
loan in 6 years? 𝑃𝑉𝐴
𝐶=
[1 − (1 + 𝑘)
𝑘
500000
𝐶=
[1 − (1 + 0.005)
0.005

11 12

2
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Solution 4 Cont. Question 5


The present value (PV) of $20 000 received in
500000 two years is always more than the PV of the
𝐶=
60.33951 same sum received in four years, assuming
each will be received with 100 per cent
𝐶 = $8,286.44 certainty. Is this true? Why?

13 14

Solution 5
True, because the longer period involves a
higher discount rate.
Put another way, a smaller sum is necessary
now to grow to a given future sum in four years
than is necessary now to grow to the same
future sum in two years.

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