Ilovepdf Merged 2

INSTITUTE AND FACULTY OF ACTUARIES
EXAMINERS’ REPORT
April 2011 examinations
Subject CT1 — Financial Mathematics

Core Technical
Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
T J Birse
Chairman of the Board of Examiners
July 2011
© Institute and Faculty of Actuaries

Subject CT1 (Financial Mathematics Core Technical) — Examiners’ Report, April 2011
General comments
Please note that different answers may be obtained to those shown in these solutions
depending on whether figures obtained from tables or from calculators are used in the
calculations but candidates are not penalised for this. However, candidates may be penalised
where excessive rounding has been used or where insufficient working is shown.
The general performance was slightly worse than in April 2010 but well-prepared candidates
scored well across the whole paper. As in previous diets, questions that required an element
of explanation or analysis, such as Q3(ii) and Q6(iii) were less well answered than those that
just involved calculation. The comments that follow the questions concentrate on areas
where candidates could have improved their performance. Where no comment is made the
question was generally answered well by most candidates.
Page 2
∫ 3 δ( s ) ds
7
1 (i) We want 1000e
∫
= 1000 e ⎢⎣ 3
( ∫5 )
⎡ 5 0.04+ 0.003s 2 ds + 7 ( 0.01+ 0.03s )ds ⎤
⎥⎦
∫3 ( 0.04 + 0.003s ) ds = ⎡⎣0.04s + 0.001 s ⎤⎦3

5 2 3 5
where
= 0.325 – 0.147 = 0.178
7
7 ⎡ 0.03 2 ⎤
and ∫ ( 0.01 + 0.03s ) ds = ⎢0.01s + s ⎥
5 ⎣ 2 ⎦5
= 0.805 − 0.425 = 0.380
⇒ accumulation at t = 7 is
1000e(
0.178+ 0.380 )
= 1000e0.558 = 1, 747.17
4×12
⎛ d (12 ) ⎞
(ii) 1747.17 ⎜ 1 − ⎟ = 1000
⎜ 12 ⎟
⎝ ⎠
⇒ d ( ) = 0.138692
12
2 Forward price of the contract is K 0 = ( S0 − I ) eδT = ( 68 − I ) e0.14×1
−0.14× 812
where I is the present value of income during the term of the contract = 2.5e
(
⇒ K 0 = 68 − 2.5e
−0.14× 812
)e 0.14
= 75.59919
Forward price a new contract issued at time r (3 months) is

( )
K = S − I * e ( ) = 71 − I ∗ e
r r
δ T −r
(
0.12× 912
)
(where I * is the present value of income during the term of the contract)
= 2.5e
−0.12× 512
( )
⇒ K 0.25 = 71 − 2.5e −0.05 e0.09 = 75.08435
Page 3
Value of original contract = ( K r − K 0 ) e ( )

−δ T − r
−0.12×912
= ( 75.08435 − 75.59919 ) e
= −0.47053 = −47.053 p
Many candidates failed to incorporate the change in the value of δ. Another common error
was in counting the number of months.
121.4 121.4 2 121.4 3

3 (i) 135, 000 = 7,900 × . ν + 8, 400 × ν + 8,800 × ν
125.6 131.8 138.7
121.4 4 121.4 5
+9, 400 × ν + (10,100 + 151, 000 ) × v
145.3 155.2
at i′ % where i′ = real yield
Approx yield:
135, 000 = (7635.828 + 7737.178 + 7702.379 + 7853.820 + 126015.077) ν5
⇒ i′ 3.1% p.a.
Try i′ = 3%, RHS = 137434.955
Try i′ = 3.5%, RHS = 134492.919
135000 − 134492.919
i′ = 0.035 − 0.005 ×
137434.955 − 134492.919
= 0.03414 (i.e. 3.4% p.a.)
(ii) The term:
121.4
8,800 ×
RPI (June 2008)
would have a lower value (i.e. the dividend paid on 30 June 2008 would have
a lower value when expressed in June 2005 money units). The real yield
would therefore be lower than 3.4% p.a.
The most common error on this question was incorrect use of the indices, e.g. many
candidates inverted them. Several candidates also had difficulty in setting up the equation of
Page 4
value. The examiners noted that a large number of final answers were given to excessive
levels of accuracy given the approximate methods used.
4 (i) We can find forward rates f2,1 and f2,2 from:
(1 + y3 )3 = (1 + y2 )2 (1 + f 2,1 ) and
(1 + y4 )4 = (1 + y2 )2 (1 + f 2,2 )
2
⇒ (1.033) = (1.032 ) (1 + f 2,1 )

3 2
⇒ f 2,1 = 3.50029 % p.a.
and (1.034 ) = (1.032 ) (1 + f 2,2 )

4 2 2
⇒ f 2,2 = 3.60039 % p.a.
(ii) (a) Price per £100 nominal
(
4 v
3.1%
+ v2
3.2%
+ v3
3.3%
) + 115 v
3.3%
3
= 4 ( 0.969932 + 0.938946 + 0.907192 ) + 115 × 0.907192
= 115.59
(b) Let yc3 = 3 − year par yield
1 = yc3 v (
3.1%
+ v2
3.2%
+ v3
3.3%
)+ v 3.3%
3
1 = yc3 ( 0.969932 + 0.938946 + 0.907192 ) + 0.907192
⇒ yc3 = 0.032957
i.e. 3.2957% p.a.
Page 5
2
⎛ i( 2) ⎞
5 (i) ⎜1 + ⎟ = 1.05 ⇒ i ( 2 ) = 4.939% (or use tables)
⎜ 2 ⎟
⎝ ⎠
0.06
g (1 − t1 ) = × 0.80 = 0.0457
1.05
So i ( ) > g (1 − t1 ) ⇒ there is a capital gain on the contract

2
(ii) Since there is a capital gain, the loan is least valuable to the investor if the
repayment is made by the borrower at the latest possible date. Hence, we
assume redemption occurs 25 years after issue in order to calculate the
minimum yield achieved.
(iii) If A is the price per £100 of loan:
( 2)
(1.05)12 + (105 − 0.35 (105 − A) ) v
2 2410
A = 100 × 0.06 × 0.80 a 12 at 5%
25
= 4.8 × 1.012348 × 14.0939 × (1.05 )12 + (105 − 0.35 (105 − A ) ) × 0.29771

2
69.0452 + 20.3187
Hence A = = 99.759
1 − 0.35 × 0.29771
⇒ Price of loan = £99,759
The majority of this question was well-answered but most candidates struggled with the two
month adjustment. This adjustment needs to be directly incorporated into the equation of
value. Calculating the price first without adjustment and then multiplying by (1+i)1/6 will lead
to the wrong answer.
6 (i) MWRR is given by:
8
10.0 × (1 + i ) + 5.5 × (1 + i ) 12 = 17.1
Try 11%, LHS = 16.996
Try 12%, LHS = 17.132
17.1 − 16.996
MMRR = 0.11 + 0.01× = 11.8%p.a.
17.132 − 16.996
Page 6
(ii) TWRR is given by:
8.5 17.1
× = 1 + i ⇒ i = 3.821%p.a.
10.0 8.5 + 5.5
(iii) MWRR is higher since fund received a large (net) cash flow at a favourable
time (i.e. just before the investment returns increased).
(iv) TWRR is more appropriate. Cash flows into and out of the fund are outside
the control of the fund manager, and should not influence the level of bonus
payable. TWRR is not distorted by amount and/or timing of cash flows
whereas MWRR is.
The calculations in parts (i) and (ii) were generally well done but parts (iii) and (iv) were
poorly answered (or not answered at all) even by many of the stronger candidates. In (iii) for
example, candidates were expected to comment on the timing of the cashflows for this
particular year.
7 (i) Let initial quarterly amount be X . Work in time units of one quarter. The
effective rate of interest per time unit is
0.08
= 0.02 (i.e.2% per quarter)
4
So
60, 000 = X a80 + 100v16 a64 + 100v32 a48 + 100v 48 a32 + 100v 64 a16 at 2%
1 − v 64
2%
(where a64 = = 35.921415)
0.02
= 39.7445 X + 2, 616.695465 + 1, 627.606705 + 907.1436682 + 382.3097071
60, 000 − 5,533.756

⇒X=
39.7445
= £1,370.41 per quarter
(ii) Interest paid at the end of the first quarter (i.e. on 1 October 1998) is
60, 000 × 0.02 = £1, 200
Hence, capital repaid on 1 October 1998 is
1370.41 − 1200 = £170.41
Page 7
Therefore, interest paid on 1 January 1999 is
( 60000 − 170.41) × 0.02 = 1196.59

⇒ capital repaid on 1 January 1999 is
1370.41 − 1196.59 = 173.82
(iii) Loan outstanding at 1 July 2011 (after repayment of instalment)
= 1670.41 a12 + 1770.41 ν12 a16 at 2%
= 1670.41×10.5753 + 1770.41× 0.78849 × 13.5777
= £36,619
Candidates found this to be the most challenging question on the paper. The easiest method
was to work in quarters with an effective rate of 2% per quarter. Where candidates worked
using a year as the time period the most common error was to allow for an increase to
payments of £100 pa when the increases were £400pa when they occurred. In part (i), the
examiners were disappointed to see many attempts with incorrect and/or insufficient working
end with the numerical answer that had been given in the question. A candidate who claims
to have obtained a correct answer after making obvious errors in the working is not
demonstrating the required level of skill and judgement and, indeed, is behaving
unprofessionally.
Part (iii) was very poorly answered with surprisingly few candidates recognising the
remaining loan was simply the present value of the last 28 payments.
8 (i) No, because the spread (convexity) of the liabilities would always be greater
than the spread (convexity) of the assets then the 3rd Redington condition
would never be satisfied.
(ii) Work in £millions
Let proceeds from four-year bond = X

Let proceeds from 20-year bond = Y
Require PV Assets = PV Liabilities
X ν 4 + Y ν 20 = 10ν3 + 20ν 6 (1)
Require DMT Assets = DMT Liabilities
⇒ 4 X ν 4 + 20Y ν 20 = 30ν3 + 120ν 6 (2)
Page 8
(2) − 4 × (1)
⇒ 16Yν20 = 40ν6 − 10ν3
40ν 6 − 10ν3 31.61258 − 8.88996

⇒Y = = = £3.11175m
16ν 20 7.30219
From (1):
10ν3 + 20ν 6 − Y ν 20 8.88996 + 15.80629 − 1.42016

X= = = £27.22973m
ν4 0.8548042

So amount to be invested in 4‐year bond is

Xν4=£23.27609m

And amount to be invested in 20-year bond is

Yν20 = £1.42016m
Require Convexity of Assets > Convexity of Liabilities
⇒ 20 X ν 6 + 420Y ν 22 > 120ν5 + 840ν8
LHS = 981.869 > 712.411 = RHS
Therefore condition is satisfied and so above strategy will immunise company

against small changes in interest rates.
Or state that spread of assets (t = 4 to t = 20) is greater than spread of

liabilities (t = 3 to t = 6).
Part (i) was poorly answered. In part (ii) many candidates correctly derived X and Y as the
proceeds from the two bonds. However, only the better candidates recognised that the
amounts to be invested (as required by the question) were therefore Xv4 and Yv20.
9 (i) PV of outgo (£000s)
⎛ 1 ⎞
105 ⎜1 + v 2 + v ⎟ + 200v15 = 366.31 at 8%
⎜ ⎟
⎝ ⎠
Page 9
PV of income
⎡ 20v + 23v 2 + 26v3 + 29v 4 ⎤

⎢ ⎥
( )
a1
⎢ + 29v51.03 1 + (1.03v ) + (1.03v ) + ... + (1.03v ) ⎥
2 24
⎣ ⎦
⎡ ⎛ 1 − (1.03)25 v 25 ⎞ ⎤
= a1 ⎢ 20v + 23v + 26v + 29v + 29v 1.03 × ⎜
2 3 4 5 ⎟⎥
⎢ ⎜ 1 − 1.03v ⎟⎥
⎣ ⎝ ⎠⎦
PV of income
= a1 {80.193 + 20.329 ×14.996} = 370.61
So NPV is 4.30 (=£4,300)
(ii) The NPV is very small. It is considerably less than the PV of the final year’s
( )
income 29 × (1.03) × a1 × v 29 = 6.272 ; therefore the DPP must fall in the
25
final year.
We know the DPP exists as the NPV > 0.
So DPP is 29 + r where
⎧ ⎛ 1 − (1.03)24 v 24 ⎞ ⎫⎪
⎪
366.31 = a1 × ⎨80.193 + 20.329 × ⎜ ⎟⎬
⎪⎩ ⎜ 1 − 1.03v ⎟⎪
⎝ ⎠⎭
+29 × 1.0325 × v 29 × ar at 8%
⇒ 366.31 = 364.335 + 6.5169ar
⇒ ar = 0.3031
⇒ v r = 0.97668 ⇒ r = 0.307
So the DPP is 29.31.
This question tended to separate out the stronger and weaker candidates. The most common
errors in part (i) were discounting for an extra year, not including the one-year annuity
factor and incorrectly calculating the geometric progression. Many candidates also lost
marks through poorly presented or illegible methods that were therefore difficult for the
examiners to follow. Part (ii) was poorly attempted with few candidates completing the
question.
Page 10
10 (i)
E (1 + it ) = 1.06
Var (1 + it ) = 0.032 = 0.0009
⎛ μ+ σ2 ⎞
⎜ 2 ⎟⎠
⇒ 1.06 = e⎝ (1)
0.0009 = e
( 2μ+σ2 )
( eσ − 1
2
) (2)
⇒
( 2 ) = 0.0009 = eσ2 − 1
(1)2 (1.06 )2
⎛ 0.0009 ⎞
⇒ σ = Ln ⎜
2
+ 1⎟
⎜ (1.06 )2 ⎟
⎝ ⎠
= 0.000800676 ( and σ = 0.0282962 )

⎛ 0.000800676 ⎞
⎜ μ+ ⎟
⇒ 1.06 = e⎝ 2 ⎠
0.000800676
∴μ = Ln (1.06 ) −
2
= 0.0578686
(ii) (a) Working in £m. Assets would accumulate to 14 × 1.04 = 14.56 < 15
⇒ Probability = 1.00
(b) The guaranteed portion of the fund would accumulate to
0.25 ×14 × 1.04 = 3.64.
Page 11
∴ non-guaranteed portion needs to accumulate to
15 − 3.64 = 11.36
∴ we require probability that

( 0.75 ×14 ) (1 + it ) < 11.36
= Pr (1 + it ) < 1.081905
= Pr ( ln (1 + it ) < ln 1.081905 )
⎛ ln (1 + it ) − 0.0578686 ln1.081905 − 0.0578686 ⎞

= Pr ⎜ < ⎟
⎝ 0.0282962 0.0282962 ⎠
= Pr ( Z < 0.7370169 ) where Z ∼ N ( 0,1) .
= 0.77
(iii) (a) Return is fixed (= 4% p.a.) ⇒ variance of return = 0
(b) Return from portfolio = 0.25 × 0.04 + 0.75 it
∴ Variance of return = 0.752Var ( it )
= 0.752 × 0.0009 = 0.00050625
[In monetary terms the variance of return for (iii)(b) will be

( £14m )2 × 0.00050625 = £ 299, 225m which is equivalent to a standard
deviation of £315,000]
This question was generally well answered by those candidates who had left enough time to
fully attempt the question. In part (i) the common errors were equating the mean to 0.06
instead of 1.06 and using 0.03 as the variance instead of 0.032. Part (ii) was also well
answered although many candidates quoted the probability of meeting liabilities when the
probability of not meeting the liabilities was asked for. Part (iii) a) was answered well by the
candidates who attempted it, while part b) was not answered well. In part (iii) answers given
in terms of the annual return and in terms of the monetary amounts were both fully
acceptable.
END OF EXAMINERS’ REPORT
Page 12
EXAMINATION
19 April 2011 (am)

Core Technical
Time allowed: Three hours
INSTRUCTIONS TO THE CANDIDATE
1. Enter all the candidate and examination details as requested on the front of your answer
booklet.
2. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
3. Mark allocations are shown in brackets.
4. Attempt all 10 questions, beginning your answer to each question on a separate sheet.
5. Candidates should show calculations where this is appropriate.
Graph paper is NOT required for this paper.
AT THE END OF THE EXAMINATION
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
CT1 A2011 © Institute and Faculty of Actuaries

1 The force of interest, δ(t), is a function of time and at any time t, measured in years, is
given by the formula
⎧⎪0.04 + 0.003t 2 for 0 < t ≤ 5

δ(t ) = ⎨
⎪⎩0.01 + 0.03t for 5 < t
(i) Calculate the amount to which £1,000 will have accumulated at t = 7 if it is

invested at t = 3. [4]
(ii) Calculate the constant rate of discount per annum, convertible monthly, which
would lead to the same accumulation as that in (i) being obtained. [3]
[Total 7]
2 A one-year forward contract on a stock is entered into on 1 January 2011 when the
stock price is £68 and the risk-free force of interest is 14% per annum. The stock is
expected to pay an annual dividend of £2.50 with the next dividend due in eight
months’ time.
On 1 April 2011, the price of the stock is £71 and the risk-free force of interest is 12%
per annum. The dividend expectation is unchanged.
Calculate the value of the contract to the holder of the long forward position on
1 April 2011. [6]
3 An investment trust bought 1,000 shares at £135 each on 1 July 2005. The trust
received dividends on its holding on 30 June each year that it held the shares.
The rate of dividend per share was as given in the table below:
30 June Rate of dividend per Retail price

in year share (£) index
2005 … 121.4
2006 7.9 125.6
2007 8.4 131.8
2008 8.8 138.7
2009 9.4 145.3
2010 10.1 155.2
On 1 July 2010, the investment trust sold its entire holding of the shares at a price of
£151 per share.
(i) Using the retail price index values shown in the table, calculate the real rate of
return per annum effective achieved by the trust on its investment. [6]
(ii) Explain, without doing any further calculations, how your answer to (i) would
alter (if at all) if the retail price index for 30 June 2008 had been greater than
138.7 (with all other index values unchanged). [2]
[Total 8]
CT1 A2011—2
4 The n-year spot rate of interest yn , is given by:
n
yn = 0.03 + for n = 1, 2, 3 and 4
1000
(i) Calculate the implied one-year and two-year forward rates applicable at time
t = 2. [3]
(ii) Calculate, assuming no arbitrage:
(a) The price at time t = 0 per £100 nominal of a bond which pays annual
coupons of 4% in arrear and is redeemed at 115% after 3 years.
(b) The 3-year par yield.

[6]
[Total 9]
5 A loan of nominal amount £100,000 was issued on 1 April 2011 bearing interest
payable half-yearly in arrear at a rate of 6% per annum. The loan is to be redeemed
with a capital payment of £105 per £100 nominal on any coupon date between 20 and
25 years after the date of issue, inclusive, with the date of redemption being at the
option of the borrower.
An investor who is liable to income tax at 20% and capital gains tax of 35% wishes to
purchase the entire loan on 1 June 2011 at a price which ensures that the investor
achieves a net effective yield of at least 5% per annum.
(i) Determine whether the investor would make a capital gain if the investment is
held until redemption. [3]
(ii) Explain how your answer to (i) influences the assumptions made in calculating
the price the investor should pay. [2]
(iii) Calculate the maximum price the investor should pay. [5]
[Total 10]
CT1 A2011—3 PLEASE TURN OVER

6 The value of the assets held by a pension fund on 1 January 2010 was £10 million.
On 30 April 2010, the value of the assets had fallen to £8.5 million. On 1 May 2010,
the fund received a contribution payment of £7.5 million and paid out £2 million in
benefits. On 31 December 2010, the value of the fund was £17.1 million.
(i) Calculate the annual effective money-weighted rate of return (MWRR) for
2010. [3]
(ii) Calculate the annual effective time-weighted rate of return (TWRR) for 2010.
[3]
(iii) Explain why the MWRR is higher than the TWRR for 2010. [2]
The fund manager’s bonus for 2010 is based on the return achieved by the fund over
the year.
(iv) State, with reasons, which of the two rates of return calculated above would be
more appropriate for this purpose. [2]
[Total 10]
7 A loan of £60,000 was granted on 1 July 1998.
The loan is repayable by an annuity payable quarterly in arrear for 20 years. The
amount of the quarterly repayment increases by £100 after every four years. The
repayments were calculated using a rate of interest of 8% per annum convertible
quarterly.
(i) Show that the initial quarterly repayment is £1,370.41. [5]
(ii) Calculate the amount of capital repaid that was included in the payment made
on 1 January 1999. [3]
(iii) Calculate the amount of capital outstanding after the quarterly repayment due
on 1 July 2011 has been made. [4]
[Total 12]
8 A company has liabilities of £10 million due in three years’ time and £20 million due
in six years’ time. The investment manager for the company is able to buy zero-
coupon bonds for whatever term he requires and has adequate monies at his disposal.
(i) Explain whether it is possible for the investment manager to immunise the
fund against small changes in the rate of interest by purchasing a single zero-
coupon bond. [2]
The investment manager decides to purchase two zero-coupon bonds, one for a term
of four years and the other for a term of 20 years. The current interest rate is 4% per
annum effective.
(ii) Calculate the amount that must be invested in each bond in order that the
company is immunised against small changes in the rate of interest. You
should demonstrate that all three Redington conditions are met. [10]
[Total 12]
CT1 A2011—4
9 A company is considering investing in a project. The project requires an initial
investment of three payments, each of £105,000. The first is due at the start of the
project, the second six months later, and the third payment is due one year after the
start of the project.
After 15 years, it is assumed that a major refurbishment of the infrastructure will be

required, costing £200,000.
The project is expected to provide a continuous income stream as follows:
• £20,000 in the second year

• £23,000 in the third year
• £26,000 in the fourth year
• £29,000 in the fifth year
Thereafter the continuous income stream is expected to increase by 3% per annum

(compound) at the start of each year. The income stream is expected to cease at the
end of the 30th year from the start of the project.
(i) Show that the net present value of the project at a rate of interest of 8% per
annum effective is £4,000 (to the nearest £1,000). [7]
(ii) Calculate the discounted payback period for the project, assuming a rate of
interest of 8% per annum effective. [5]
[Total 12]
10 The annual rates of return from a particular investment, Investment A, are

independently and identically distributed. Each year, the distribution of (1 + it ) , where
it is the rate of interest earned in year t , is log-normal with parameters μ and σ2 .
The mean and standard deviation of it are 0.06 and 0.03 respectively.
(i) Calculate μ and σ2 . [5]
An insurance company has liabilities of £15m to meet in one year’s time. It currently
has assets of £14m. Assets can either be invested in Investment A, described above,
or in Investment B which has a guaranteed return of 4% per annum effective.
(ii) Calculate, to two decimal places, the probability that the insurance company
will be unable to meet its liabilities if:
(a) All assets are invested in Investment B.
(b) 75% of assets are invested in Investment A and 25% of assets are
invested in Investment B. [6]
(iii) Calculate the variance of return from each of the portfolios in (ii)(a) and
(ii)(b). [3]
[Total 14]
END OF PAPER
CT1 A2011—5
EXAMINERS’ REPORT
September 2011 examinations

Core Technical
Purpose of Examiners’ Reports
The Examiners’ Report is written by the Principal Examiner with the aim of helping
candidates, both those who are sitting the examination for the first time and who are using
past papers as a revision aid, and also those who have previously failed the subject. The
Examiners are charged by Council with examining the published syllabus. Although
Examiners have access to the Core Reading, which is designed to interpret the syllabus, the
Examiners are not required to examine the content of Core Reading. Notwithstanding that,
the questions set, and the following comments, will generally be based on Core Reading.
For numerical questions the Examiners’ preferred approach to the solution is reproduced in
this report. Other valid approaches are always given appropriate credit; where there is a
commonly used alternative approach, this is also noted in the report. For essay-style
questions, and particularly the open-ended questions in the later subjects, this report contains
all the points for which the Examiners awarded marks. This is much more than a model
solution – it would be impossible to write down all the points in the report in the time allowed
for the question.
T J Birse
December 2011

Subject CT1 (Financial Mathematics Core Technical) — Examiners’ Report, September 2011
General comments on Subject CT1
CT1 provides a grounding in financial mathematics and its simple applications. It introduces
compound interest, the time value of money and discounted cashflow techniques which are
fundamental building blocks for most actuarial work.
Comments on the September 2011 paper
The general performance was considerably better than in September 2010 and also slightly
better than in April 2011. Well-prepared candidates scored well across the whole paper.
As in previous diets, questions that required an element of explanation or analysis, such as
Q5(ii) and Q9(iv) were less well answered than those that just involved calculation. Marginal
candidates should note that it is important to explain and show understanding of the concepts
and not just mechanically go through calculations. The comments that follow the questions
concentrate on areas where candidates could have improved their performance. Where no
comment is made the question was generally answered well by most candidates.
(1 − 365 ) ( )
−91
1 91 × 0.08 = 1 + i 365
−91
0.980055 = (1 + i ) 365
1 + i = 1.08416 ⇒ i = 8.416%
2 Issued by the government

Pay regular interest
Redeemable at a given redemption date
Normally liquid/marketable
More or less risk-free relative to inflation
Low expected return
Low default risk
Coupon and capital payments linked to an index of prices…
… with a time lag.
This type of bookwork question is common in CT1 exam papers. As such, it was disappointing
that only about one-sixth of candidates obtained full marks here (which could be achieved by
listing six distinct features).
3 Let the annual rate of payment = X
( 4)
Present value of the payments = Xa
4
Present value of the payments needed from the annuity is:
(12 ) (12 )
8, 000a v 4 + 3, 000a v 7
3 10
( 4) (12 ) (12 )
Xa = 8, 000a v 4 + 3, 000a v 7
4 3 10
a3 = 2.7232 i = 1.031059
d( )
4
a4 = 3.5460 a10 = 7.7217 i = 1.026881 v 4 = 0.82270 v 7 = 0.71068

d( )
12
i i i
X a4 = 8, 000 a v 4 + 3, 000 a v7
d (4)
d (12 ) 3
d (12 ) 10
X ×1.031059 × 3.5460 = 8, 000 ×1.026881× 2.7232 × 0.82270

+3, 000 × 1.026881× 7.7217 × 0.71068
3.65614 X = 18, 404.80 + 16.905.51
Page 3
X = £9, 657.81
∴ Quarterly payment is: £2,414.45.
Many candidates struggled to allow correctly for the Government pension. In some cases,
candidates would have scored more marks if they had explained their methodology and their
workings more clearly.
4 (i) The fund value on 30 June 2009 will be:
1.5 × 1.01 = 1.515
The fund value on 31 December 2009 will be:
(1.5 ×1.01 + 6 ) ×1.02 = 7.6653

The fund value on 31 December 2010 will be:
⎡⎣(1.5 ×1.01 + 6 ) ×1.02 + 4 ⎤⎦ ×1.05 = 12.2486

TWRR is i such that:
1.515 7.6653 12.2486

= (1 + i ) = 1.0817
2
× ×
1.5 7.515 11.6653
∴ i = 4.005%
(This can also be calculated directly from the rates of return for which no
marks would be lost).
(ii) The equation of value is:
1.5 (1 + i ) + 6.0 (1 + i ) + 4 (1 + i ) = 12.2486

2 11 2
Try i = 4% LHS = 12.146
Try i = 4.5% LHS = 12.22754
Try i = 5% LHS = 12.3094
Page 4
Interpolate:
12.2486 − 12.22754
i = 0.045 + × 0.005
12.3094 − 12.22754
= 0.04629 or 4.63%
A common error was to assume that the 1% and 2% rates of return were annualised figures
rather than returns over a six-month period.
5 (i) Forward price is accumulated value of the share less the accumulated value of
the expected dividends:
F = 9.56 (1.03) − 0.2 (1.03) − 0.2 (1.03)

9 8 2
12 12 12
= 9.7743 – 0.20398 – 0.20099
= £9.3693
(ii) (a) Although the share will be bought in nine months, it is not necessary to
take into account the expected share price. The current share price
already makes an allowance for expected movements in the price and
the investor is simply buying an instrument that is (more or less)
identical to the underlying share but with deferred payment. As such,
under given assumptions, the forward can be priced from the underlying
share.
(b) An option does not have to be exercised. As such, movements in the

share price in one direction will benefit the holder whereas movements
in the other direction will not harm him. The more volatile is the
underlying share price, the more potential there is for gain for the
holder of the option (with limited risk of loss), compared with holding
the underlying share. This is not the case for a forward which has to be
exercised.
Part (i) was well-answered but part (ii) was very poorly answered. The examiners anticipated
that many candidates would find part (ii)(b) challenging but it was pleasing to see some of
the strongest candidates give some well-reasoned explanations for this part.
Page 5
( a +bt )dt
5
6 (i) 45e ∫0 = 55 (1)
( a +bt )dt
10
45e ∫0 = 120 (2)
From (1)
5
⎡ bt 2 ⎤
45exp ⎢ at + ⎥ = 55
⎣⎢ 2 ⎦⎥
0
⎛ 55 ⎞
ln ⎜ ⎟ = 5a + 12.5b = 0.2007 (1a)
⎝ 45 ⎠
From (2)
10
⎡ bt 2 ⎤
45exp ⎢ at + ⎥ = 120
⎢⎣ 2 ⎥⎦
0
⎛ 120 ⎞
ln ⎜ ⎟ = 10a + 50b = 0.98083
⎝ 45 ⎠
From (1a)
10a = 0.4014 − 25b (2a)
Substituting into (2a)
0.4014 + 25b = 0.98083
0.98083 − 0.4014
∴b = = 0.02318
25
Substituting into (1a)
5a + 12.5 × 0.02318 = 0.2007
0.2007 − 12.5 × 0.0231772

∴a = = −0.01781
5
(ii) 45e10δ = 120

120 ⎛ 120 ⎞
e10δ = ;10δ = ln ⎜ ⎟ = 0.98083
45 ⎝ 45 ⎠
∴δ = 0.09808 or 9.808 %
Page 6
7 (i) Expected price of the shares in five years is:
X = 2v + 2.5v 2 + 2.5 ×1.01× v3 + 2.5 ×1.012 v 4 + ...
(
= 2v + 2.5v 2 + 2.5v 2 1.01v + 1.012 v 2 + .... )
1
1.01v + 1.012 v 2 + ... at 8% =
i'
1.08
where i ' = − 1 = 0.069307
1.01
2.5 × 0.85734
X = 2 × 0.92593 + 2.5 × 0.85734 +
0.069307
= 3.9952 + 30.9254 = 34.9206
Equation of value for the investor is:
12 (1 + i ) = 34.9206
5
i = 0.23817 or 23.817%
12 (1 + i ) = 34.9206 − ( 34.9206 − 12 ) × 0.25

5
(ii)
where i is the net rate of return.
12 (1 + i ) = 29.1905
5
i = 0.1946 or 19.46%
(iii) The cash flow received in nominal terms is still the same: 29.190495
The equation of value expressed in real terms is:
29.1905
12 = v5 where f = 0.04
(1 + f ) 5
12 × (1.04 )
5
v =
5
= 0.50016
29.1905
1
∴ v = 0.50016 5 = 0.87061
i = 14.86%
Page 7
8 (i) The present value of the assets is equal to the present value of the liabilities at
the starting rate of interest.
The duration /discounted mean term/volatility of the assets is equal to that of

the liabilities.
The convexity of the assets (or the spread of the timings of the asset
cashflows) around the discounted mean term is greater than that of the liabilities.
(ii) (a) PV of liabilities is: £100m a40 at 4%
= £100m×19.7928
= £1,979.28m
(b) The duration of the liabilities is:
t = 40 t = 40
∑ 100t vt / ∑ 100vt (working in £m)
t =1 t =1
t = 40
100 ∑ t vt
t =1
100 ( Ιa )40
= = at 4%
1,979.28 1,979.28
100 × 306.3231
= = 15.4765 years
1,979.28
(iii) Let x = nominal amount of five-year bond

y = nominal amount of 40-year bond.
working in £m
1,979.28 = xv5 + yv 40 ⎯ (1)

30, 632.31 = 5 xv5 + 40 yv 40 ⎯ (2)
multiply equation (1) by 5.

9,896.4 = 5 xv5 + 5 yv 40 ⎯ (1a)
subtract (1a) from (2) to give

20735.91 = 35yv 40
20, 735.91
=y
35 × v 40
Page 8
with v 40 = 0.20829
y = 2,844.38
Substitute into (1) to give:
1,979.28 = Xv5 + 2,844.38 × 0.20829
v5 = 0.82193
1,979.28 − 2,844.38 × 0.20829

= x = 1, 687.28
0.82193
Therefore £1,687.28m nominal of the five-year bond and £2,844.38m nominal

of the 40-year bond should be purchased.
(iv) (a) The duration of the liabilities is 15.4765
15.4765
Therefore the volatility of the liabilities is =14.88125%
1.04
The value of the liabilities would therefore change by:
1.5 × 0.1488125 × 1,979.28m = £441.81m
and the revised present value of the liabilities will be £2,421.09m.
(b) PV of liabilities is: £100m a40 at 2.5%

1 − 1.025−40
= £100m× 0.025
= £2,510.28m.
(c) The PV of liabilities has increased by £531m. This is significantly

greater than that estimated in (iv) (a). This estimation will be less valid
for large changes in interest rates as in this case.
The first three parts were generally well-answered but, in part (iv), the examiners were
surprised that so few candidates were able to use the duration to estimate the change in the
value of the liability.
Page 9
9 (i) (a) The theoretical rate of return that could be achieved over a given time
period in the future from investment in government bonds today.
(b) The theoretical rate of return that could be achieved between the
current time and a given future time from investment in government
bonds.
(c) The gross redemption yield that could be theoretically achieved by

investing in government bonds of different terms to redemption. The
yield curve represents a statistical average gross redemption yield.
(ii)
Time Government Valuation rate P.V factor
bond yield of interest
1 0.02 0.031 0.96993
2 0.04 0.052 0.90358
3 0.06 0.073 0.80947
4 0.08 0.094 0.69812
5 0.1 0.115 0.58026
PV = 10 ( 0.96993 + 0.90358 + 0.80947 + 0.69812 + 0.58026 ) + 100 × 0.58026

= 97.6396.
(iii) GRY is such that: 97.6396 = 10a5 + 100v5

Try 11% a5 = 3.69590 v5 = 0.59345 RHS = 96.30397
Try 10% a5 = 3.7908 v5 = 0.62092 RHS = 100 [calculation not necessary]
Interpolate to find i:
97.6396 − 96.30397
i=− × 0.01 + 0.11
100 − 96.30397
⇒ i = 0.10639 or 10.64%
(iv) It is reasonable for the investor to price a corporate bond with reference to the
rates of return from government bonds which may be (more or less) risk free.
A risk premium will then need to be added.
It is also not unreasonable that this risk premium rises with term as the
uncertainty regarding credit risk rises.
This question proved to be the most difficult on the paper. The examiners had anticipated that
some candidates would have difficulty with part (i) but it was disappointing to see the number
of candidates who were unable to give even a basic description of a spot rate and a forward
rate. Part (iv) was also very poorly answered and whilst it had been anticipated that only the
Page 10
strongest candidates would make all the relevant points, the examiners were surprised at how
many candidates failed to score any marks on this part.
10 (i) The payback period measures the earliest time at which the project breaks
even but takes no account either of interest on borrowings or on cash flows
received after the payback period. It is therefore a poor measure of ultimate
profitability.
(ii) The present value of preparation costs is (in £m):
2a2 @ 4% per annum effective.
i i
= 2. .a2 = 1.019869 a2 = 1.8861
δ δ
= 2 × 1.019869 ×1.8861 = 3.847
The present value the stadium building costs is (in £m):
4 12 5 12 6 12 13 12
200v + 200 × 1.05v + 200 ×1.052 v + ... + 200 ×1.059 v
200v
4 12
(1 + 1.05v + 1.05 v 2 2
+ ... + 1.059 v9 )
4 12 ⎡1 − 1.0510 v10 ⎤
= 200v ⎢ ⎥
⎣⎢ 1 − 1.05v ⎦⎥
4 12
with v = 0.96154 v10 = 0.67556 1.0510 = 1.62889 v = 0.83820
⎛ 1 − 1.62889 × 0.67556 ⎞
= 200 × 0.83820 × ⎜ ⎟
⎝ 1 − 1.05 × 0.96154 ⎠
= £1, 750.837
Present value of admin. costs is (£m):
(12 )
100a v13 @ 4%
2
i
with = 1.021537 v13 = 0.60057 a2 = 1.8861
d (12 )
= 100 ×1.021537 ×1.8861× 0.60057
= 115.714
Page 11
Present value of revenue (£m):
i
3,300a1 v14 with = 1.019869 a1 = 0.9615 v14 = 0.57748
δ
= 3,300 ×1.019869 × 0.9615 × 0.57748
= 1,868.781
NPV = 1,868.781 – 115.714 – 1,750.837 – 3.847 = –£1.617m.
Therefore should not make a bid.
(iii) One way of dealing with this would be to multiply the NPV of all the revenues
and costs that are only received if the bid is won by 0.1.
The costs of preparing the bid would be incurred for certain and therefore not
multiplied by 0.1. This adjustment would make it less likely the bid will go
ahead because the only certain item is a cost.
This question contained a potential ambiguity regarding the timing of the administration
costs. Although the examiners felt that the approach given in the model solution was the most
logical, candidates who assumed that the administration costs were only payable during
2025 were given full credit. This question was answered well and it was very pleasing to see
that (a) candidates managed their time efficiently and so left enough time to make a good
attempt at the question with the most marks and (b) candidates who made calculation errors
still clearly explained their method and so were able to pick up significant marks for their
working.
END OF EXAMINER’S REPORT
Page 12
EXAMINATION
27 September 2011 (am)

Core Technical
booklet.
supervisor.
question paper.
CT1 S2011 © Institute and Faculty of Actuaries

1 A 91-day treasury bill is issued by the government at a simple rate of discount of 8%
per annum.
Calculate the annual effective rate of return obtained by an investor who purchases
the bill at issue. [3]
2 State the characteristics of index-linked government bonds. [3]
3 An individual intends to retire on his 65th birthday in exactly four years’ time. The
government will pay a pension to the individual from age 68 of £5,000 per annum
monthly in advance. The individual would like to purchase an annuity certain so that
his income, including the government pension, is £8,000 per annum paid monthly in
advance from age 65 until his 78th birthday. He is to purchase the annuity by a series
of payments made over four years quarterly in advance starting immediately.
Calculate the quarterly payments the individual has to make if the present value of
these payments is equal to the present value of the annuity he wishes to purchase at a
rate of interest of 5% per annum effective. Mortality should be ignored. [6]
4 A pension fund makes the following investments (£m):
1 January 2009 1 July 2009 1 January 2010

1.5 6.0 4.0
The rates of return earned on money invested in the fund were as follows:
1 January 2009 to 1 July 2009 to 1 January 2010 to

30 June 2009 31 December 2009 31 December 2010
1% 2% 5%
Assume that 1 January to 30 June and 1 July to 31 December are precise half-year
periods.
(i) Calculate the time-weighted rate of return per annum effective over the two
years from 1 January 2009 to 31 December 2010. [3]
(ii) Calculate the money-weighted rate of return per annum effective over the two
years from 1 January 2009 to 31 December 2010. [3]
[Total 6]
CT1 S2011—2
5 A nine-month forward contract is issued on 1 March 2011 on a stock with a price of
£9.56 per share at that date. Dividends of 20 pence per share are expected on both
1 April 2011 and 1 October 2011.
(i) Calculate the forward price, assuming a risk-free rate of interest of 3% per
annum effective and no arbitrage. [4]
(ii) (a) Explain why the expected price of the share in nine months’ time is not
needed to calculate the forward price.
(b) Explain why the price of an option would be explicitly dependent on

the variance of the share price but the price of a forward would not be.
[4]
[Total 8]
a + bt where a and b are constants. An amount of £45 invested at time t = 0
accumulates to £55 at time t = 5 and £120 at time t = 10.
(i) Calculate the values of a and b. [5]
(ii) Calculate the constant force of interest per annum that would give rise to the
same accumulation from time t = 0 to time t = 10. [2]
[Total 7]
7 An investment manager is considering investing in the ordinary shares of a particular

company.
The current price of the shares is 12 pence per share. It is highly unlikely that the
share will pay any dividends in the next five years. However, the investment manager
expects the company to pay a dividend of 2 pence per share in exactly six years’ time,
2.5 pence per share in exactly seven years’ time, with annual dividends increasing
thereafter by 1% per annum in perpetuity.
In five years’ time, the investment manager expects to sell the shares. The sale price
is expected to be equal to the present value of the expected dividends from the share at
that time at a rate of interest of 8% per annum effective.
(i) Calculate the effective gross rate of return per annum the investment manager
will obtain if he buys the share and then sells it at the expected price in five
years’ time.
[6]
(ii) Calculate the net effective rate of return per annum the investment manager
will obtain if he buys the share today and then sells it at the expected price in
five years’ time if capital gains tax is payable at 25% on any capital gains. [3]
(iii) Calculate the net effective real rate of return per annum the investment
manager will obtain if he buys the share and then sells it at the expected price
in five years’ time if capital gains tax is payable at 25% on any capital gains
and inflation is 4% per annum effective. There is no indexation allowance. [3]
[Total 12]
CT1 S2011—3 PLEASE TURN OVER

8 (i) State the conditions that are necessary for an insurance company to be
immunised from small, uniform changes in the rate of interest. [2]
An insurance company has liabilities to pay £100m annually in arrear for the next 40
years. In order to meet these liabilities, the insurance company can invest in zero
coupon bonds with terms to redemption of five years and 40 years.
(ii) (a) Calculate the present value of the liabilities at a rate of interest of 4%
per annum effective.
(b) Calculate the duration of the liabilities at a rate of interest of 4% per

annum effective. [5]
(iii) Calculate the nominal amount of each bond that the fund needs to hold so that
the first two conditions for immunisation are met at a rate of interest of 4% per
annum effective. [5]
(iv) (a) Estimate, using your calculations in (ii) (b), the revised present value
of the liabilities if there were a reduction in interest rates by 1.5% per
annum effective.
(b) Calculate the present value of the liabilities at a rate of interest of 2.5%
(c) Comment on your results to (iv) (a) and (iv) (b). [6]
[Total 18]
9 (i) Describe the information that an investor can obtain from the following yield
curves for government bonds:
(a) A forward rate yield curve.

(b) A spot rate yield curve.
(c) A gross redemption yield curve. [6]
An investor is using the information from a government bond spot yield curve to
calculate the present value of a corporate eurobond with a term to redemption of
exactly five years. The investor will value each payment that is due from the bond at a
rate of interest equal to j = i + 0.01 + 0.001t where:
• t is the time in years at which the payment is due
• i is the annual t-year effective spot rate of interest from the government bond spot
yield curve and i = 0.02t for t ≤ 5
The eurobond pays annual coupons of 10% of the nominal amount of the bond and is
redeemed at par.
(ii) Calculate the present value of the eurobond. [6]
(iii) Calculate the gross redemption yield from the eurobond. [3]
CT1 S2011—4
(iv) Explain why the investor might use such a formula for j to determine the
interest rates at which to value the payments from the corporate eurobond. [3]
[Total 18]
10 A country’s football association is considering whether to bid to host the World Cup
in 2026. Several countries aspiring to host the World Cup will be making bids.
Regardless of whether the bid is successful, the association will incur various costs.
For two years, starting on 1 January 2012, the association will incur costs at a rate of
£2m per annum, assumed to be paid continuously, to prepare the bid.
If the football association is successful, the following costs will be incurred from
1 January 2016 until 31 December 2025:
• One stadium will be built each year for ten years. The first stadium will be built in
2016 and is expected to cost £200m; the stadium built in 2017 is expected to cost
£210m; and so on, with the cost of each stadium rising by 5% each year. The costs
of building each stadium are assumed to be incurred halfway through the relevant
year.
• Administration costs at a rate of £100m per annum will be incurred, payable

monthly in advance from 1 January 2025 until 31 December 2026.
• Revenues from television, ticket receipts, advertising and so on are expected to be

£3,300m and are assumed to be received continuously throughout 2026.
(i) Explain why the payback period is not a good indicator of whether this project
is worthwhile. [3]
The football association decides to judge whether to go ahead with the bid by
calculating the net present value of the costs and revenues from a successful bid on
1 January 2012 at a rate of interest of 4% per annum effective.
(ii) Determine whether the association should make the bid. [13]
The football association is discussing how it might factor into its calculations the fact
that it is not certain to win the right to host the World Cup because other countries are
also bidding.
(iii) Explain how you might adjust the above calculations if the probability of
winning the right to host the World Cup is 0.1 and whether this adjustment
would make it more likely or less likely that the bid will go ahead. [3]
[Total 19]
END OF PAPER
CT1 S2011—5
EXAMINERS’ REPORT
Subject CT1 – Financial Mathematics

Core Technical
Introduction
candidates, both those who are sitting the examination for the first time and who are using
past papers as a revision aid, and also those who have previously failed the subject. The
Examiners are charged by Council with examining the published syllabus. Although
Examiners have access to the Core Reading, which is designed to interpret the syllabus, the
Examiners are not required to examine the content of Core Reading. Notwithstanding that,
the questions set, and the following comments, will generally be based on Core Reading.
this report. Other valid approaches are always given appropriate credit; where there is a
commonly used alternative approach, this is also noted in the report. For essay-style
questions, and particularly the open-ended questions in the later subjects, this report contains
all the points for which the Examiners awarded marks. This is much more than a model
solution – it would be impossible to write down all the points in the report in the time allowed
for the question.
T J Birse
July 2012

Subject CT1 (Financial Mathematics) – April 2012 – Examiners’ Report
Comments on the April 2012 paper
The general performance was broadly similar to the previous two exams. Well-prepared
candidates scored well across the whole paper. As in previous diets, questions that required
an element of explanation or analysis, such as Q2(iii), Q5(iii) and Q6(iv) were less well
answered than those that just involved calculation. Marginal candidates should note that it is
important to explain and show understanding of the concepts and not just mechanically go
through calculations. The comments that follow the questions concentrate on areas where
candidates could have improved their performance. Where no comment is made the question
was generally answered well by most candidates.
Page 2
1 (i) Price, P, of £100 nominal stock is:
P = 3v y1 + 3v 2y2 + 103v3y3
where
y1 = 0.041903
y2 = 0.043625
y3 = 0.045184
⇒ P = 95.845
And gross redemption yield, i%, solves:
95.845 = 3a3 + 100v3 at i %
Try 4% RHS = 97.225

5% RHS = 94.554
97.225 − 95.845
⇒ i = 0.04 + 0.01×
97.225 − 94.554
= 0.0452
i.e. 4.5% p.a.
(ii) y1, y2 and y3 as above. y4 = 0.046594
( )
1 = ( yc4 ) v y1 + v 2y2 + v3y3 + vY44 + v 4y4
⇒ 1 = yc4 × 3.587225 + 0.8334644

⇒ yc4 = 0.04642 i.e. 4.642% p.a.
2 (i) TWRR, i , is given by:
2.9 4.2
× = 1 + i ⇒ i = 0.204 or 20.4% p.a.
2.3 2.9 + 1.5
(ii) MWRR, i , is given by:
8
2.3 × (1 + i ) + 1.5 (1 + i ) 12
= 4.2
Page 3
Then, we have:
i = 12% ⇒ LHS = 4.1937 ⎫ ⎛ 4.2 − 4.1937 ⎞

⎬ ⇒ i = 0.12 + ( 0.13 − 0.12 ) × ⎜ ⎟
i = 13% ⇒ LHS = 4.2263 ⎭ ⎝ 4.2263 − 4.1937 ⎠
= 0.122
or 12.2% p.a.
(iii) The MWRR is lower as fund performs better before the cash inflow than after.
Then, as the fund is larger after the cash inflow on 1 May 2011, the effect of
the poor investment performance after this date is more significant in the
calculation of the MWRR.
The calculations were performed well but the quality of the explanations in part (iii) was
often poor. This type of explanation is commonly asked for in CT1 exams. To get full marks,
candidates should address the specific situation given in the question rather than just repeat
the bookwork.
3 (i) Let R = annual repayment
9%
500, 000 = R a10 = R × 6.4177
⇒ R = 77, 910.04
and total interest = 10 × 77,910.04 − 500, 000
= 279,100
(ii) (a) Capital outstanding at beginning of 8th year is:
77910.04 a39% = 77909.53 × 2.5313
= 197, 213.28
Let R ′ be new payment per annum then
( 4)
R′ a = R′ ×1.043938 × 3.0373 = 197, 213.28
4
⇒ R′ = 62,196.62
and quarterly payment is £15,549.16
Page 4
(b) Interest content of 2nd quarterly payment is:
(
15549.16 × 1 − v12%
4 33
= 5383.41 )
[Or Capital in 1st quarterly payment is
( 1
15549.16 − 197213.28 × 1.12 4 − 1 = 9,881.77 )
So capital outstanding after 1st quarterly payment
= 197213.28 − 9881.77 = 187331.51
⇒ Interest in next payment is
187331.51× ⎛⎜1.12 4 − 1⎞⎟ = 5383.41 ]

1
⎝ ⎠
Generally answered well but a number of candidates made errors in calculating the
remaining term in part (ii)
4 (i) The “no arbitrage” assumption means that neither of the following applies:
(a) an investor can make a deal that would give her or him an immediate
profit, with no risk of future loss;
nor
(b) an investor can make a deal that has zero initial cost, no risk of future
loss, and a non-zero probability of a future profit.
(ii) The current value of the forward price of the old contract is:
2 12 %
7.20 × (1.025 ) − 1.20 a
4
5
whereas the current value of the forward price of a new contract is:
2 12 %
10.45 − 1.20 a
5
Hence, current value of old forward contract is:
10.45 − 7.20 × (1.025 ) = £2.5025

4
Page 5
(iii) The current value of the forward price of the old contract is:
−9
7.20 (1.025 ) (1.03)
4
= 6.0911
whereas the current value of the forward price of a new contract is:
−5
10.45 (1.03) = 9.0143
⇒ current value of old forward contract is:
9.0143 − 6.0911 = £2.9232
This was the most poorly answered question on the paper but well-prepared candidates still
scored full marks. Some candidates in part (ii) assumed that the dividend income was
received during the lifetime of the forward contract. Whilst the examiners did not believe that
such an approach was justified, candidates who assumed this alternative treatment of the
income were not penalised. It was very clear that the poor performance on the question was
not as result of this alternative interpretation.
5 (i) The equation of value is:
1309.5 = 100 a ( ( ) + (1.05) v

5
4 5 5 ( 4)
a
5
( 4)
+ … + (1.05 ) v 20 a
20
5 ) −12a( )
4
25
Rearranging:
⎛ 25 ⎞
( 4 ) ⎜ 1 − (1.05v ) ⎟ ( 4)
1309.5 = 100a − 12a
5 ⎜ 5 ⎟
⎝ 1 − (1.05v ) ⎠
25
At 9%, RHS is:

⎛ ⎛ 1.05 ⎞25 ⎞
⎜ 1− ⎜ ⎟ ⎟
⎜ ⎝ 1.09 ⎠ ⎟
100 ×1.033144 × 3.8897 × − 12 ×1.033144 × 9.8226
⎜ 1.05 ⎞ ⎟
5
⎛
⎜⎜ 1 − ⎜ ⎟ ⎟⎟
⎝ ⎝ 1.09 ⎠ ⎠
0.607292
= 401.8570 × − 121.7779
0.170505
= 1309.53 ⇒ IRR is 9% p.a.
Page 6
(ii) For Project B the equation of value is
( 4) ( 4)
1000 = 85a + v 20 90a
20 5
Roughly 1000 85a25 ⇒ i 7%
At 7% RHS is 1039.05
= 85 × 1.043380 × 10.5940 + 0.25842 × 1.043380 × 4.1002 × 90
8% RHS is 956.78
= 85 × 1.049519 × 9.8181 + 0.21455 × 1.049519 × 3.9927 × 90
⇒i 7.5% p.a.
(iii) Project A is more attractive since it has the higher IRR. However, the investor
will also need to take into account other factors such as:
• the outlay is much higher for Project A than Project B
• the interest rate at which the investor might need to borrow at to finance a
project since it will affect the net present values and discounted payback
periods of the projects
• the risks for each project that the rents and expenses will not be those
assumed in the calculations.
In part (i) candidates were asked to demonstrate that the internal rate of return was a given
value. In such questions, candidates should set up the equation of value and clearly show
each stage of their algebra and their calculations (including the evaluation of all factors that
make up the equation). Many candidates claimed that they had shown the correct answer
despite obvious errors and/or insufficient working. Candidates who tried to create a
“proof” where the arguments didn’t follow logically gained few marks. In this type of
question, if you can’t complete a proof, it is better to show how far you have got and be open
about being unable to proceed further. This will generally gain more intermediate markst.
Part (ii) was answered well but in part (iii) few candidates came up with any of the other
factors that should be considered.
Page 7
6 (i) Price per £100 nominal is given by:
3.158%
⎛ 1 − v18 ⎞
P = 5 × a18 + 100v18
3.158% = 5 × ⎜⎜ 3.158% 18
⎟⎟ + 100v3.158% = 125.00
⎝ 0.03158 ⎠
(ii) As coupons are payable annually and the gross redemption yield is equal to
the annual coupon rate, the new price per £100 nominal is £100.
5%
⎛ 1 − v13 ⎞
i.e. P = 5a13 + 100v13 = 5⎜ 5% 13
⎟⎟ + 100v5% = 100.00
5% ⎜ 0.05
⎝ ⎠
(iii) Equation of value is:
125.00 = 5a5 + 100v5 ⇒ i = 0%

Thus, the investor makes a return of 0% per annum over the period.
(iv) Longer-dated bonds are more volatile.
Thus, as a result of the rise in gross redemption yields from 3.158% per annum
on 1 March 2007 to 5% on 1 March 2012, the fall in the price of the bond
would be greater.
Thus, as the income received over the period would be unchanged, the overall
return achieved would be reduced (as a result of the greater fall in the capital
value).
[In fact, the price on 1 March 2007 would have been £133.91 per £100
nominal falling to £100 per £100 nominal on 1 March 2012.
i.e. in this case, we need to find i such that 133.91 = 5a5 + 100V 5 ⇒ i < 0% .]
The first three parts were generally well-answered although relatively few candidates noticed
that parts (ii) and (iii) could be answered quickly and consequently many candidates made
avoidable calculation errors.
μ+ 1 2 σ 2
7 (i) E (1 + i ) = e
0.05+ 1 2×0.004
=e
= 1.0533757
∴ E [i ] = 0.0533757 since E (1 + i ) = 1 + E ( i )
Page 8
Let A be the accumulation of £5000 at the end of 20 years
then E [ A] = 5000 s20 at rate j = 0.0533757
( (1 + j ) − 1) 20
= 5000 × (1 + j )
j
= 5000
(1.0533757 20
) ×1.0533757
−1
0.0533757
= £180,499
(ii) Let the accumulation be S20
S20 has a log-normal distribution with parameters 20μ and 20σ2
( )
∴ E [ S20 ] = e
20μ+ 12 20σ2
{or (1 + j ) }
20
= exp ( 20 × 0.05 + 10 × 0.004 )
= e1.04 = 2.829217
(
ln S20 ∼ N 20μ, 20σ2 )
i.e. ln S20 ∼ N (1, 0.08)
( )
P S20 > e1.04 = P ( ln S20 > 1.04 )
⎛ 1.04 − 1 ⎞
= P⎜ Z > ⎟ where Z ∼ N ( 0,1)
⎝ 0.08 ⎠
= P ( Z > 0.14 ) = 1 − Φ ( 0.14 )
= 1 − 0.56 = 0.44
Questions regarding annual investments are comparatively rarely asked on this topic and
students seemed to struggle with part (i). Part (ii) was answered better in general than
equivalent questions in previous exams.
Page 9
8 (i) for t > 8
v ( t ) = exp − {∫ 5
0
8 t
0.04 + 0.003t 2 dt + ∫ 0.01 + 0.03tdt + ∫ 0.02dt
5 8 }
⎧ 5 8 t⎫
= exp − ⎨ ⎡ 0.04t + 0.001t 3 ⎤ + ⎡ 0.01t + 0.015t 2 ⎤ + [ 0.02t ]8 ⎬
⎩ ⎣ ⎦ 0 ⎣ ⎦ 5 ⎭
{ ( )
= exp − 0.2 + 0.125 + 0.01× 3 + 0.015 82 − 52 + 0.02t − 0.02 × 8 }
= exp − {0.325 + 0.615 + 0.02t − 0.16}
=e (
− 0.78+ 0.02t )
Hence PV of £1,000 due at t = 10 is:
1000 × exp − ( 0.78 + 0.02 ×10 ) = £375.31
4×10
⎛ d ( 4) ⎞
(ii) 1000 ⎜1 − ⎟ = 375.31
⎜ 4 ⎟
⎝ ⎠
40
⎛ d ( 4) ⎞ 375.31
⎜1 − ⎟ =
⎜ 4 ⎟ 1000
⎝ ⎠
⎛ ⎛ 375.31 ⎞ 140 ⎞
d( )
4
= 4 ⎜1 − ⎜ ⎟
⎜ ⎝ 1000 ⎟⎠ ⎟
⎝ ⎠
= 0.09681
18
(iii) PV = ∫ ρ ( t ) v ( t ) dt
10
= ∫ 100e0.01t × e (
18 − 0.78+ 0.02t )
10
18
= 100e−0.78 ∫ e−0.01t dt
10
⎧ −0.01t ⎤18 ⎫
−0.78 ⎪ ⎡ e ⎪
= 100e ⎨⎢ ⎥ ⎬
⎪⎩ ⎢⎣ −0.01 ⎥⎦10 ⎪⎭
Page 10
=
0.01
e (
100 −0.78 −0.1 −0.18
e −e )
= £318.90
Parts (i) and (ii) were answered well. Some candidates made errors in part (iii) by not
discounting the payment stream back to time 0.
(i)
(
PV = 100 × 0.35 1.03v + 1.03 × 1.05v 2 + 1.03 × 1.05 × 1.06v3 + 1.03 × 1.05 × 1.062 v 4 + )
⎛ 1.03 × 1.05 × 1.06v3 ⎞
= 35 ⎜1.03v + 1.03 × 1.05v 2 + ⎟⎟ @ 8%
⎜ 1 − 1.06 v
⎝ ⎠
⎛ 1.03 1.03 ×1.05 1.03 × 1.05 ×1.06 1.08 ⎞
= 35 ⎜ + + ×
⎝ 1.08 1.082 1.083 0.02 ⎟⎠
= 35 ( 0.95370 + 0.92721 + 49.14223)
= £1785.81
(ii) Real rate of return is i such that:
⎛ 110 110 2 110 3 ⎞ 110 3

1720 = 35 ⎜1.03 × v + 1.03 ×1.05 × v + 1.03 ×1.05 ×1.06 × v ⎟ + 1800 × v
⎝ 112.3 113.2 113.8 ⎠ 113.8
( )
= 35 1.0089047v + 1.050928v 2 + 1.108110v3 + 1739.894552v3
= 35.3116645v + 36.78248v 2 + 1778.678402v3
For initial estimate, assume all income received at end of 3 years:
1720 ≈ 1850.77v3
⇒ v ≈ 0.9758696 ⇒ i ≈ 2.4727
Try i = 2.5%, RHS = 1721.14 ≈ 1720
so i = 2.5%
Most candidates made a good attempt at part (i) although slight errors in setting up the
equation and/or in the calculation were common. Many candidates struggled with setting up
the required equation in part (ii).
Page 11
10 (i) Working in 000’s
PVL = 200a20 + 300v15 @ 8%

= 200 × 9.818147 + 300 × 0.315242
= 2058.20199
i.e. £2,058,201.99
(ii)
200v + 200 × 2v 2 + 200 × 3v3 + + 200 × 20v 20 + 300 ×15v15
DMTL =
200a20 + 300v15
200 ( Ia )20 + 300 ×15v15
= @ 8%
2058.20199
200 × 78.9079 + 300 ×15 × 0.31524
=
2058.20199
17200.175
= = 8.3569 years
2058.20199
(iii) Redington’s first two conditions are:
⇒ PVL = PVA
⇒ DMTL = DMTA
Let the nominal amount in securities A and B be X and Y respectively.
( ) (
PVA = PVL ⇒ X 0.09a12 + v12 + Y 0.04a30 + v30 = 2058201.99 @ 8% )
⇒ X ( 0.09 × 7.5361 + 0.39711) + Y ( 0.04 ×11.2578 + 0.09938 )
⇒ 1.075361X + 0.549689Y = 2058201.99
2058201.99 − 0.549689Y
⇒X=
1.075361
DMTA = DMTL ⇒
( ) (
X 0.09 ( Ia )12 + 12v12 + Y 0.04 ( Ia )30 + 30v30 ) = 8.3569
2058201.99
(
⇒ X 0.09 ( Ia )12 + 12v 12
) + Y ( 0.04 ( Ia )
30 )
+ 30v30 = 17200175 @ 8%
⇒ X ( 0.09 × 42.17 + 12 × 0.39711) + Y ( 0.04 × 114.7136 + 30 × 0.09938 ) = 17200175
⇒ 8.56066 X + 7.56986Y = 17200175
⇒ 8.56066 ×
( 2058201.99 − 0.549689Y ) + 7.56986Y = 17200175
1.075361
⇒ 3.19394Y = 815370.9
⇒ Y = 255287, X = 1783470
Page 12
Hence company should purchase £1,783,470 nominal of security A and

£255,287 nominal of security B for Redington’s first two conditions to be
satisfied.
(iv) Redington’s third condition is that the convexity of the asset cash flow series
is greater than the convexity of the liability cash flow series. Therefore the
convexities of the asset cash flows and the liability cash flows will need to be
calculated and compared.
Generally well answered but candidates’ workings in part (iii) were often unclear which
made it difficult for examiners to award marks when calculation errors had been made.
Page 13
EXAMINATION
24 April 2012 (am)

Core Technical
booklet.
supervisor.
question paper.

1 In a particular bond market, n -year spot rates can be approximated by the function
0.06 − 0.02e−0.1n .
(i) Calculate the gross redemption yield for a 3-year bond which pays coupons of
3% annually in arrear, and is redeemed at par. Show all workings. [6]
(ii) Calculate the 4-year par yield. [3]

[Total 9]
2 The value of the assets held by an investment fund on 1 January 2011 was £2.3
million.
On 30 April 2011, the value of the assets had risen to £2.9 million and, on 1 May
2011, there was a net cash inflow to the fund of £1.5 million. On 31 December 2011,
the value of the assets was £4.2 million.
(i) Calculate the annual effective time-weighted rate of return (TWRR) for 2011.
[2]
(ii) Calculate, to the nearer 0.1%, the annual effective money-weighted rate of
return (MWRR) for 2011. [4]
(iii) Explain why the TWRR is significantly higher than the MWRR for 2011. [2]
[Total 8]
3 A company has borrowed £500,000 from a bank. The loan is to be repaid by level
instalments, payable annually in arrear for ten years from the date the loan is made.
The annual instalments are calculated at an effective rate of interest of 9% per annum.
(i) Calculate:
(a) the amount of the level annual instalments.
(b) the total amount of interest which will be paid over the ten-year term.
[3]
At the beginning of the eighth year, immediately after the seventh instalment has been
made, the company asks for the loan to be rescheduled over a further four years from
that date. The bank agrees to do this on condition that the rate of interest is increased
to an effective rate of 12% per annum for the term of the rescheduled instalments and
that repayments are made quarterly in arrear.
(ii) (a) Calculate the amount of the new quarterly instalment.
(b) Calculate the interest content of the second quarterly instalment of the
rescheduled loan repayments.
[5]
[Total 8]
CT1 A2012–2
4 (i) Explain what is meant by the “no arbitrage” assumption in financial
mathematics. [2]
An investor entered into a long forward contract for a security four years ago and the
contract is due to mature in five years’ time. The price of the security was £7.20 four
years ago and is now £10.45. The risk-free rate of interest can be assumed to be 2.5%
per annum effective throughout the nine-year period.
(ii) Calculate, assuming no arbitrage, the value of the contract now if the security
will pay dividends of £1.20 annually in arrear until maturity of the contract.
[3]
(iii) Calculate, assuming no arbitrage, the value of the contract now if the security
has paid and will continue to pay annually in arrear a dividend equal to 3% of
the market price of the security at the time of payment. [3]
[Total 8]
5 An investor is considering two projects, Project A and Project B. Project A involves

the investment of £1,309,500 in a retail outlet. Rent is received quarterly in arrear for
25 years, at an initial rate of £100,000 per annum. It is assumed that the rent will
increase at a rate of 5% per annum compound, but with increases taking place every
five years. Maintenance and other expenses are incurred quarterly in arrear, at a rate
of £12,000 per annum. The retail outlet reverts to its original owner after 25 years for
no payment.
Project B involves the purchase of an office building for £1,000,000. The rent is to be
received quarterly in advance at an initial rate of £85,000 per annum. It is assumed
that the rent will increase to £90,000 per annum after 20 years. There are no
maintenance or other expenses. After 25 years the property reverts to its original
owner for no payment.
(i) Show that the internal rate of return for project A is 9% per annum effective.
[5]
(ii) Calculate the annual effective internal rate of return for Project B. Show your
working. [4]
(iii) Discuss the extent to which the answers to parts (i) and (ii) above will
influence the investor’s decision over which project to choose. [3]
[Total 12]
CT1 A2012–3 PLEASE TURN OVER

6 A fixed-interest bond pays annual coupons of 5% per annum in arrear on 1 March
each year and is redeemed at par on 1 March 2025.
On 1 March 2007, immediately after the payment of the coupon then due, the gross
redemption yield was 3.158% per annum effective.
(i) Calculate the price of the bond per £100 nominal on 1 March 2007. [3]
On 1 March 2012, immediately after the payment of the coupon then due, the gross
redemption yield on the bond was 5% per annum.
(ii) State the new price of the bond per £100 nominal on 1 March 2012. [1]
A tax-free investor purchased the bond on 1 March 2007, immediately after payment
of the coupon then due, and sold the bond on 1 March 2012, immediately after
payment of the coupon then due.
(iii) Calculate the gross annual rate of return achieved by the investor over this
period. [2]
(iv) Explain, without doing any further calculations, how your answer to part (iii)
would change if the bond were due to be redeemed on 1 March 2035 (rather
than 1 March 2025). You may assume that the gross redemption yield at both
the date of purchase and the date of sale remains the same as in parts (i) and
(ii) above. [3]
[Total 9]
7 The annual yields from a fund are independent and identically distributed. Each year,
the distribution of 1 + i is log-normal with parameters μ = 0.05 and σ2 = 0.004, where
i denotes the annual yield on the fund.
(i) Calculate the expected accumulation in 20 years’ time of an annual investment

in the fund of £5,000 at the beginning of each of the next 20 years. [5]
(ii) Calculate the probability that the accumulation of a single investment of £1

made now will be greater than its expected value in 20 years’ time. [5]
[Total 10]
CT1 A2012–4
8 The force of interest, δ(t), at time t is given by:
⎧0.04 + 0.003t 2 for 0 < t ≤ 5

⎪
δ ( t ) = ⎨0.01 + 0.03t for 5 < t ≤ 8
⎪0.02 for t > 8
⎩
(i) Calculate the present value (at time t = 0) of an investment of £1,000 due at
time t = 10. [4]
(ii) Calculate the constant rate of discount per annum convertible quarterly, which
would lead to the same present value as that in part (i) being obtained. [2]
(iii) Calculate the present value (at time t = 0) of a continuous payment stream
payable at the rate of 100e 0.01t from time t = 10 to t = 18. [4]
[Total 10]
9 An ordinary share pays dividends on each 31 December. A dividend of 35p per share
was paid on 31 December 2011. The dividend growth is expected to be 3% in 2012,
and a further 5% in 2013. Thereafter, dividends are expected to grow at 6% per
annum compound in perpetuity.
(i) Calculate the present value of the dividend stream described above at a rate of
interest of 8% per annum effective for an investor holding 100 shares on
1 January 2012. [4]
An investor buys 100 shares for £17.20 each on 1 January 2012. He expects to sell
the shares for £18 on 1 January 2015.
(ii) Calculate the investor’s expected real rate of return.
You should assume that dividends grow as expected and use the following
values of the inflation index:
Year: 2012 2013 2014 2015
Inflation index 110.0 112.3 113.2 113.8

at start of year:
[5]
[Total 9]

10 A company has the following liabilities:
• annuity payments of £200,000 per annum to be paid annually in arrear for the next
20 years
• a lump sum of £300,000 to be paid in 15 years
The company wishes to invest in two fixed-interest securities in order to immunise its
liabilities.
Security A has a coupon rate of 9% per annum and a term to redemption of 12 years.
Security B has a coupon rate of 4% per annum and a term to redemption of 30 years.
Both securities are redeemable at par and pay coupons annually in arrear. The rate of
interest is 8% per annum effective.
(i) Calculate the present value of the liabilities. [3]
(ii) Calculate the discounted mean term of the liabilities. [4]
(iii) Calculate the nominal amount of each security that should be purchased so
that Redington’s first two conditions for immunisation against small changes
in the rate of interest are satisfied for this company. [8]
(iv) Describe the further calculations that will be necessary to determine whether
the company is immunised against small changes in the rate of interest. [2]
[Total 17]
END OF PAPER
CT1 A2012–6
EXAMINERS’ REPORT

Core Technical
Introduction
candidates, both those who are sitting the examination for the first time and using past papers
as a revision aid and also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The
Examiners have access to the Core Reading, which is designed to interpret the syllabus, and
will generally base questions around it but are not required to examine the content of Core
Reading specifically or exclusively.
this report; other valid approaches are given appropriate credit. For essay-style questions,
particularly the open-ended questions in the later subjects, the report may contain more points
than the Examiners will expect from a solution that scores full marks.
D C Bowie
December 2012

Subject CT1 (Financial Mathematics) – September 2012 – Examiners’ Report
The general performance was of a lower standard compared with the previous two exams.
Well-prepared candidates scored well across the whole paper. As in previous diets, questions
that required an element of explanation or analysis, such as Q3(ii), Q4(ii) and Q9(iii) were
less well answered than those that just involved calculation. This is an area to which
attention should be paid. Candidates should note that it is important to explain and show
understanding of the concepts and not just mechanically go through calculations. At the
other end of the spectrum, there was a difficulty for many candidates when it came to
answering questions involving introductory ideas.
The comments that follow the questions concentrate on areas where candidates could have
improved their performance. Where no comment is made the question was generally
answered well by most candidates.
Page 2
1 Let d be the annual simple rate of discount.
The discounted value of 100 in the deposit account would be x such that:
x = 100(1.04)−91/365 = 99.0269
∴ to provide the same effective rate of return a treasury bill that pays 100 must have a
⎛ 91 ⎞
price of 99.0269 and 100 ⎜1 − × d ⎟ = 99.0269
⎝ 365 ⎠
91 99.0269
∴ 1− ×d = = 0.990269
365 100
365
d = (1-0.990269) × =0.03903
91
Many candidates scored full marks on this question but many others failed to score any
marks at all. Some candidates incorrectly used (1-nd) as an accumulation factor
−δ /4 0.08
2 (i) e = 1− = 0.98 ∴δ = 0.080811
4
4
⎛ 0.08 ⎞
(ii) (1 + i)−1 = ⎜1 − ⎟ = 0.92237 ∴ i = 0.084166
⎝ 4 ⎠
12 4
⎛ d (12) ⎞ ⎛ 0.08 ⎞ (12)
(iii) ⎜⎜1 − ⎟ = ⎜1 − ⎟ = 0.92237 ∴ d = 0.080539
⎝ 12 ⎟⎠ ⎝ 4 ⎠
A lot of marginal candidates scored very badly on this question even though it was covering
an introductory part of the syllabus.
140 600
3 (i) (1 + i )2.5 = × = 2.05882
120 140 + 200
∴ 1 + i = 1.33490
∴ i = 33.49% p.a. effective.
(ii) The money weighted rate of return weights performance according to the
amount of money in the fund. The fund was performing better after it had
been given the large injection of money on 1/1/2011.
Page 3
Part (i) was answered well. The type of explanation asked for in part (ii) is commonly asked
for in CT1 exams. To get full marks, candidates should address the specific situation given in
the question rather than just repeat the bookwork.
4 (i) Present value of dividends, I, is:
I= v ( 1
4 +v
1
2 +v
3
4
)
Calculated at i′% when (1 + i ') = (1.04)2 = 1.0816
−1 − 12 − 34
So I = 1.0816 4 + 1.0816 + 1.0816
= 2.88499
Hence, forward price, F, is:
10
F = (10 − 2.88499)(1 + i′) 12 at 8.16%
= (10 − 2.88499 ) × 1.0816
10
12 = £7.5956
(ii) The price of the forward can be determined from the price of the share (for
which it is a close substitute). The forward is like the share but with delayed
settlement and without dividends.
5 (i) The characteristics of a Eurobond are:

• Medium- or long-term borrowing
• Unsecured
• Regular coupon payments
• Redeemed at par
• Issued and traded internationally/not in the jurisdiction of any one country
• Can be denominated in any currency (e.g. not the currency of issuer)
• Tend to be issued by large companies, governments or supra-national
organisations
• Yields depend on issue size and issuer (or marketability and risk)
• Issue characteristics may vary – market free to allow innovation
(ii) (a) The characteristics of a certificate of deposit are:

• Tradable certificate issued by banks stating that money has been
deposited
• Terms to maturity between one and six months
• Interest payable on maturity/issued at a discount
• Security and marketability will depend on issuing bank
• Active secondary market
Page 4
12
⎛ i (12 ) ⎞
Answer is i such that (1.01) ⎟ = (1.02 ) giving
12 24
(b) ⎜1 +
⎜ 12 ⎟
⎝ ⎠
i( ) = 36.119%
12
6 (i) Amount of loan is:
100( Ia)10 + 100a10 at 6% p.a.
= 100 ×36.9624 + 100 × 7.3601

= 3696.24 + 736.01 = £4,432.25
(ii) (a) the o/s loan after sixth instalment is:
100( Ia)4 + 700 a4
=100 × 8.4106 + 700 × 3.4651 = 841.06 + 2425.57 = £3,266.64
The interest component is therefore:
0.06 × 3266.64 = £196.00
(b) The capital component =
800-196.00 = £604.00
(iii) The capital remaining after the seventh instalment is

3266.64 – 604.00 = 2662.64
Let the new instalment = X
Xa8 = 2, 662.64 at 8%
a8 = 5.7466; X = 2,662.64/5.7466 = £463.34
7 (i) Expected annual interest rate in both ten-year periods =

0.04 ×0.3 + 0.06 × 0.7 = 0.054 or 5.4%
Amount of the investment would be X such that:
X (1.054)20 = 200,000
∴ X = £69,858.26
Page 5
(ii) Expected accumulation factors in both ten-year periods are:
0.3 (1.04)10 + 0.7(1.06)10 = 1.697667
The accumulation factors in each ten-year period are independent.
Therefore the expected accumulation is:
69,858.26 × 1.697667 × 1.697667
= £201,336.55
Therefore the value of investment over and above £200,000 = £1,336.55.
(iii) The extreme outcomes for the investment are:
69,858.26 × 1.0420 = 153,068.06

69,858.26 × 1.0620 = 224,044.91.
Therefore the range is: £70,976.85
Many candidates struggled with this question and seemed to have difficulty particularly with
part (ii). Part (iii) was also badly answered even though part (ii) was not needed to answer
part (iii).
8 (i) t≤9
t
− ∫ (0.03+0.01 s ) ds
v(t ) = e 0
⎡ 0.01s 2 ⎤ t
− ⎢0.03s + ⎥
⎢⎣ 2 ⎥⎦
=e 0
− ⎡0.03t +0.005t 2 ⎤
=e ⎣ ⎦
t>9
⎡9 t ⎤
− ⎢ ∫ δ( s ) ds + ∫ 0.06 ds ⎥
V (t ) = e ⎢⎣ 0 9 ⎥⎦
= V (9).e0.06(t −9)
= e−0.675 .e−0.06(t −9)
= e−(0.135+0.06t )
Page 6
(ii) (a) PV = 5, 000 e−(0.135+0.06×15)

= 5, 000 e−1.035
= £1, 776.13
(b) 1,776.13 eδ×15 = 5,000
eδ×15 = 2.81511
15δ = ln 2.81511
ln 2.81511
δ= = 0.0690
15
(iii)
15
− (0.135+ 0.06t )
P.V . = ∫e ×100 e−0.02t dt
11
15
= ∫ 100 e−0.135−0.08t dt
11
15
−0.135 ⎡ e−0.08t ⎤
= 100 e ⎢ ⎥
⎢⎣ −0.08 ⎥⎦11
= 100 e−0.135 (5.18479 − 3.76493)
= 124.055
Generally answered well but some candidates lost marks in part (i) by not deriving the
discount factor for t < 9.
9 (i) Expectations theory: yields on short and long-term bonds are determined by
expectations of future interest rates as it is assumed that a long-term bond is a
substitute for a series of short-term bonds.
[If interest rates are expected to rise (fall) long-term bonds will have higher
(lower) yields that short-term bonds.]
Liquidity preference: it is assumed that investors have an inherent preference

for short-term bonds because interest-rate sensitivity is lower. As such, (there
is an upward bias on the expectations-based yield curve) and longer-term
bonds will offer a higher expected return than implied by expectations theory
on its own. N.B. the part in brackets is not in core reading.
Market segmentation: bonds of different terms to redemption are attractive to

different investors with different liabilities.
Page 7
The supply of bonds of different terms to redemption will depend on the

strategy of the relevant issuer. The term structure is determined by the
interaction of supply and demand in each term-to-redemption segment.
(ii) Duration =
∑ tCt νt = 4 × ( Ia)n + 100n vn
∑ Ct νt 4 × an + 100 νn
For n = 1 to 5. Clearly duration on one-year bond is one year.
Term ( Ia)n 100νn an n100νn 4( Ia ) n

3 5.3580 86.384 2.7232 259.152 21.432
5 12.5664 78.353 4.3295 391.765 50.2656
Duration of three-year bond:
21.432 + 259.152
= 2.884 years
4 × 2.7232 + 86.384
Duration of five-year bond:
50.2656 + 391.765
= 4.620 years
4 × 4.3295 + 78.353
(iii) The duration of a bond is the average time of the cashflows weighted by
present value. The coupon payments of the 8% coupon bond will be a higher
proportion of the total proceeds than for the 4% coupon bond. Thus, a greater
proportion of the total proceeds of the 8% coupon bond will be received
before the end of the term. The average time of the cashflows will be shorter
and hence the duration will be lower.
(iv) Option 1
The equation of value would be:
95 = 4a4 + 79ν5
The rate of return is zero (incoming and outgoing cash flows are equal).
Option 2
The equation of value would be:
95 = 4a4 + ν 4 a8 + 100ν12
i = 2.5%
Page 8
RHS = 4 × 3.762 + 0.90595 × 7.1701 + 100 × 0.74356

= 15.0479 + 6.4958 + 74.3556 = 95.8993
i = 3%
RHS = 4 × 3.7171 + 0.88849 × 7.0197 + 100 ×0.70138

= 14.8684 + 6.2369 + 70.1380
= 91.2433
By interpolation:
⎛ 95.8998 − 95 ⎞
i = 0.005 × ⎜ ⎟ + 0.025
⎝ 95.8998 − 91.2433 ⎠
= 0.025966 or 2.6% per annum effective.
Hence Option 2 would provide the higher rate of return
(v) Two of the following:
• Option 2 creates a higher duration bond which might not be suitable for
the investor
….e.g. alternative investments may be available in the longer term
• The credit risk over the longer duration may be greater
• The inflation risk over the longer duration may be greater
• There may be tax implications because of the differing capital and income
combinations.
• the institution could reinvest the proceeds from option 1 at whatever rate
of return prevails.
Part (i) was often poorly answered even though this was bookwork and candidates also
struggled with part (ii). In part (ii) it is important to include the correct units for the
duration (in this case, years). Most candidates made a good attempt at part (iv) even if some
made calculation errors (e.g. in the calculation of the outstanding term of the bond under
Option 2). Marginal candidates scored badly on parts (iii) and (v).
10 (i) The payback period simply looks at the time when the total incoming cash
flows are greater than the total outgoing cash flows. It takes no account of
interest at all.
Though the discounted payback period takes account of interest that would
have to be paid on loans, it only looks at when loans used to finance outgoing
cash flows would be repaid and not at the overall profitability of the projects.
(ii) (a) Outgoing cash flow = £3m
In £m, at time t, total incoming cash flows are £0.64t
Page 9
We need t such that 3 = 0.64t
t=3 = 4.6875 years

0.64
(b) Present value of incoming cash flows at time t is:
⎛ 1 − νt ⎞
0.64at = 0.64 ⎜
⎜ δ ⎟⎟ where δ = 0.039221
⎝ ⎠
Require t such that:
⎛ 1 − νt ⎞
0.64 ⎜ =3
⎜ 0.039221 ⎟⎟
⎝ ⎠
1 - νt = 0.183848
νt = 0.816152
t ln ν = ln 0.816152
ln 0.816152
t =
ln ν
−0.203155
=− = 5.1798 years
−0.039221
(iii) Crossover point is the rate of interest at which the n.p.v. of the two projects is
equal. As the present value of the cash outflows for both projects is the same
at all rates of interest, the crossover point is the rate of interest at which the
present value of the cash inflows from both projects is equal.
P.V of cash inflows from Project B = 0.64a6

P.V of cash inflows from Project A =
1
1 2 5 12
0.5 ν 2 + 1.1× 0.5 × ν1 + " + 1.15 × 0.5 × ν
⎡1 − 1.16 × ν 6 ⎤
1
= 0.5ν ⎢ 2
⎥
⎢⎣ 1 − 1.1× ν ⎥⎦
Therefore require i such that:
1 ⎡ 1 − 1.1 ν ⎤
6 6
0.64 a6 − 0.5 ν 2 ⎢ ⎥=0
⎣⎢ 1 − 1.1ν ⎦⎥
Page 10
Let i = 4%
a6 = 5.2421 i = 1.019869
δ
1
ν 2 = 0.98058 ν = 0.96154
ν 6 = 0.79031
1.16 = 1.77156
⎡1 − 1.77156 × 0.79031 ⎤
LHS = 0.64 × 5.2421× 1.019869 − 0.5 × 0.98058 ⎢
⎣ 1 − 1.1× 0.96154 ⎥⎦
= 3.4216 – 0.49029 ×6.93490 = 3.4216 – 3.4001
= 0.0215
Let i = 0%
⎡1 − 1.77156 ⎤
LHS = 0.64 × 6 − 0.5 × ⎢ = 3.84 - 3.8578 = -0.0178
⎣ 1 − 1.1 ⎥⎦
Given that NPV of Project A is greater than that of project B at 0% per annum
effective and the reverse is true at 4% per annum effective, the NPV of the two
projects must be equal at some point between 0% and 4%.
(iv) Project A
Duration is:
1
ν 2 0.5(0.5 + 1.1×1.5ν + 1.12 × 2.5 ν 2 + 1.13 × 3.5ν3 + 1.14 × 4.5ν 4 + 1.15 × 5.5 × ν5 )
0.49029 × 6.93490
Term in brackets is
0.5 + 1.58654 + 2.79678 + 4.14139 + 5.63183 + 7.28047 = 21.93702.
0.98059 × 0.5 × 21.93702

∴ Duration = = 3.163 years
0.49029 × 6.93490
Project B
6
0.64 ∫ t νt dt
Duration is : 0
=
( Ia )6
=
( i
δ a6 − 6ν 6 )δ
6 a6 i a6
δ
0.64 ∫ νt dt
0
Page 11
=
(1.019869 × 5.2421 − 6 × 0.79031) 0.039221
1.019869 × 5.2421
15.41000
= 2.882 years
5.3462
(v) Project A has a longer duration and therefore the present value of its incoming
cash flows is more sensitive to changes in the rate of interest. As such, when
the interest rate rises, the present value of incoming cash flows falls more
rapidly than for Project B.
Most candidates could calculate the discounted payback period but struggled with the
undiscounted equivalent. As in Q9, the units should be included within the answer. The
working of many candidates in part (iii) was often unclear even when the formulae were
correctly derived. In part (iv) many candidates incorrectly thought the duration should be
( Ia )6
for Project B.
a6
Page 12
EXAMINATION
3 October 2012 (am)

Core Technical
booklet.
supervisor.
question paper.

1 An investor is considering two investments. One is a 91-day deposit which pays a
rate of interest of 4% per annum effective. The second is a treasury bill.
Calculate the annual simple rate of discount from the treasury bill if both investments
are to provide the same effective rate of return. [3]
2 The nominal rate of discount per annum convertible quarterly is 8%.
(i) Calculate the equivalent force of interest. [1]
(ii) Calculate the equivalent effective rate of interest per annum. [1]
(iii) Calculate the equivalent nominal rate of discount per annum convertible
monthly. [2]
[Total 4]
3 An investment fund is valued at £120m on 1 January 2010 and at £140m on 1 January

2011. Immediately after the valuation on 1 January 2011, £200m is paid into the
fund. On 1 July 2012, the value of the fund is £600m.
(i) Calculate the annual effective time-weighted rate of return over the two-and-a
half year period. [3]
(ii) Explain why the money-weighted rate of return would be higher than the time-
weighted rate of return. [2]
[Total 5]
4 A ten-month forward contract was issued on 1 September 2012 for a share with a
price of £10 at that date. Dividends of £1 per share are expected on 1 December
2012, 1 March 2013 and 1 June 2013.
(i) Calculate the forward price assuming a risk-free rate of interest of 8% per
annum convertible half-yearly and no arbitrage. [4]
(ii) Explain why it is not necessary to use the expected price of the share at the
time the forward matures in the calculation of the forward price. [2]
[Total 6]
CT1 S2012–2
5 (i) State the characteristics of a Eurobond [4]
(ii) (a) State the characteristics of a certificate of deposit.
(b) Two certificates of deposit issued by a given bank are being traded. A
one-month certificate of deposit provides a rate of return of 12 per cent
per annum convertible monthly. A two-month certificate of deposit
provides a rate of return of 24 per cent per annum convertible monthly.
Calculate the forward rate of interest per annum convertible monthly in

the second month, assuming no arbitrage. [4]
[Total 8]
6 A loan is to be repaid by an increasing annuity. The first repayment will be £200 and
the repayments will increase by £100 per annum. Repayments will be made annually
in arrear for ten years. The repayments are calculated using a rate of interest of 6%
(i) Calculate the amount of the loan [2]
(ii) (a) Calculate the interest component of the seventh repayment.

(b) Calculate the capital component of the seventh repayment.
[4]
(iii) Immediately after the seventh repayment, the borrower asks to have the
original term of the loan extended to fifteen years and wishes to repay the
outstanding loan using level annual repayments. The lender agrees but
changes the interest rate at the time of the alteration to 8% per annum
effective.
Calculate the revised annual repayment. [3]

[Total 9]
CT1 S2012–3 PLEASE TURN OVER

7 An individual wishes to make an investment that will pay out £200,000 in twenty
years’ time. The interest rate he will earn on the invested funds in the first ten years
will be either 4% per annum with probability of 0.3 or 6% per annum with probability
0.7. The interest rate he will earn on the invested funds in the second ten years will
also be either 4% per annum with probability of 0.3 or 6% per annum with probability
0.7. However, the interest rate in the second ten year period will be independent of
that in the first ten year period.
(i) Calculate the amount the individual should invest if he calculates the
investment using the expected annual interest rate in each ten year period. [2]
(ii) Calculate the expected value of the investment in excess of £200,000 if the
amount calculated in part (i) is invested. [3]
(iii) Calculate the range of the accumulated amount of the investment assuming the
amount calculated in part (i) is invested. [2]
[Total 7]
given by the formula
⎧0.03 + 0.01t for 0 ≤ t ≤ 9

δ(t ) = ⎨
⎩0.06 for 9 < t
(i) Derive, and simplify as far as possible, expressions for ν(t) where ν(t) is the
present value of a unit sum of money due at time t. [5]
(ii) (a) Calculate the present value of £5,000 due at the end of 15 years.
(b) Calculate the constant force of interest implied by the transaction in

part (a). [4]
A continuous payment stream is received at rate 100e −0.02t units per annum between
t = 11 and t = 15.
(iii) Calculate the present value of the payment stream. [4]

[Total 13]
CT1 S2012–4
9 (i) Describe three theories that have been put forward to explain the shape of the
yield curve. [7]
The government of a particular country has just issued five bonds with terms to
redemption of one, two, three, four and five years respectively. The bonds are
redeemed at par and have coupon rates of 4% per annum payable annually in arrear.
(ii) Calculate the duration of the one-year, three-year and five-year bonds at a
gross redemption yield of 5% per annum effective. [6]
(iii) Explain why a five-year bond with a coupon rate of 8% per annum would have
a lower duration than a five-year bond with a coupon rate of 4% per annum.
[2]
Four years after issue, immediately after the coupon payment then due the
government is anticipating problems servicing its remaining debt. The government
offers two options to the holders of the bond with an original term of five years:
Option 1: the bond is repaid at 79% of its nominal value at the scheduled time with no
final coupon payment being paid.
Option 2: the redemption of the bond is deferred for seven years from the original
redemption date and the coupon rate reduced to 1% per annum for the remainder of
the existing term and the whole of the extended term.
Assume the bonds were issued at a price of £95 per £100 nominal.
(iv) Calculate the effective rate of return per annum from Options 1 and 2 over the
total life of the bond and determine which would provide the higher rate of
return. [6]
(v) Suggest two other considerations that bond holders may wish to take into
account when deciding which options to accept. [2]
[Total 23]

10 Two investment projects are being considered.
(i) Explain why comparing the two discounted payback periods or comparing the
two payback periods are not generally appropriate ways to choose between
two investment projects. [3]
The two projects each involve an initial investment of £3m. The incoming cash flows
from the two projects are as follows:
Project A
In the first year, Project A generates cash flows of £0.5m. In the second year it will
generate cash flows of £0.55m. The cash flows generated by the project will continue
to increase by 10% per annum until the end of the sixth year and will then cease.
Assume that all cash flows are received in the middle of the year.
Project B
Project B generates cash flows of £0.64m per annum for six years. Assume that all
cash flows are received continuously throughout the year.
(ii) (a) Calculate the payback period from Project B.
(b) Calculate the discounted payback period from Project B at a rate of

interest of 4% per annum effective.
[5]
(iii) Show that there is at least one “cross-over point” for Projects A and B between
0% per annum effective and 4% per annum effective where the cross-over
point is defined as the rate of interest at which the net present value of the two
projects is equal. [6]
(iv) Calculate the duration of the incoming cash flows from Projects A and B at a
rate of interest of 4% per annum effective. [6]
(v) Explain why the net present value of Project A appears to fall more rapidly
than the net present value of Project B as the rate of interest increases. [2]
[Total 22]
END OF PAPER
CT1 S2012–6
EXAMINATION
15 April 2013 (pm)

Core Technical
booklet.
supervisor.
question paper.

1 The value of the assets held by an investment fund on 1 January 2012 was £1.3
million.
On 30 September 2012, the value of the assets was £1.9 million.

On 1 October 2012, there was a net cash outflow from the fund of £0.9 million.
On 31 December 2012, the value of the assets was £0.8 million.
(i) Calculate the annual effective time-weighted rate of return (TWRR) for 2012.
[2]
(ii) Calculate the annual effective money-weighted rate of return (MWRR) for
2012 to the nearest 1%. [3]
(iii) Explain why the MWRR is significantly higher than the TWRR. [2]
[Total 7]
2 (i) Explain the main difference:
(a) between options and futures.

(b) between call options and put options.
[4]
(ii) A one-year forward contract is issued on 1 April 2013 on a share with a price
at that date of £10.50. Dividends of £1.10 per share are expected on 30
September 2013 and 31 March 2014. On 1 April 2013, the 6-month risk-free
spot rate of interest is 4.5% per annum convertible half-yearly and the
12-month risk-free spot rate of interest is 5% per annum convertible half-
yearly.
Calculate the forward price at issue, stating any further assumptions made. [4]
[Total 8]
3 Three bonds each paying annual coupons in arrear of 6% and redeemable at £103 per
£100 nominal reach their redemption dates in exactly one, two and three years’ time,
respectively. The price of each bond is £97 per £100 nominal.
(i) Calculate the gross redemption yield of the 3-year bond. [3]
(ii) Calculate the one-year and two-year spot rates implied by the information
given. [3]
[Total 6]
CT1 A2013–2
4 An investor is interested in purchasing shares in a particular company.
The company pays annual dividends, and a dividend payment of 30 pence per share
has just been made.
Future dividends are expected to grow at the rate of 5% per annum compound.
(i) Calculate the maximum price per share that the investor should pay to give an
effective return of 9% per annum. [4]
(ii) Without doing any further calculations, explain whether the maximum price
paid will be higher, lower or the same if:

(a) after consulting the managers of the company, the investor increases
his estimate of the rate of growth of future dividends to 6% per annum.
(b) as a result of a government announcement, the general level of future

price inflation in the economy is now expected to be 2% per annum
higher than previously assumed.
(c) general economic uncertainty means that, whilst the investor still
estimates future dividends will grow at 5% per annum, he is now much
less sure about the accuracy of this assumption.
You should consider the effect of each change separately. [6]

[Total 10]
5 The force of interest per unit time at time t, δ(t), is given by:
⎧0.1 − 0.005t for t < 6

δ(t ) = ⎨
⎩0.07 for t ≥ 6
(i) Calculate the total accumulation at time 10 of an investment of £100 made at

time 0 and a further investment of £50 made at time 7. [4]
(ii) Calculate the present value at time 0 of a continuous payment stream at the
rate £50e0.05t per unit time received between time 12 and time 15. [5]
[Total 9]

6 A cash sum of £10,000 is invested in a fund and held for 15 years. The yield on the
investment in any year will be 5% with probability 0.2, 7% with probability 0.6 and
9% with probability 0.2, and is independent of the yield in any other year.
(i) Calculate the mean accumulation at the end of 15 years. [2]
(ii) Calculate the standard deviation of the accumulation at the end of 15 years. [5]
(iii) Without carrying out any further calculations, explain how your answers to
parts (i) and (ii) would change (if at all) if:
(a) the yields had been 6%, 7% and 8% instead of 5%, 7%, and 9% per
annum, respectively.
(b) the investment had been held for 13 years instead of 15 years.
[4]
[Total 11]
7 An insurance company has liabilities of £6 million due in 8 years’ time and £11
million due in 15 years’ time. The assets consist of two zero-coupon bonds, one
paying £X in 5 years’ time and the other paying £Y in 20 years’ time. The current
interest rate is 8% per annum effective. The insurance company wishes to ensure that
it is immunised against small changes in the rate of interest.
(i) Determine the values of £X and £Y such that the first two conditions for
Redington’s immunisation are satisfied. [8]
(ii) Demonstrate that the third condition for Redington’s immunisation is also
satisfied. [2]
[Total 10]
CT1 A2013–4
8 A car manufacturer is to develop a new model to be produced from 1 January 2016
for six years until 31 December 2021. The development costs will be £19 million on
1 January 2014, £9 million on 1 July 2014 and £5 million on 1 January 2015.
It is assumed that 6,000 cars will be produced each year from 2016 onwards and that
all will be sold.
The production cost per car will be £9,500 during 2016 and will increase by 4% each
year with the first increase occurring in 2017. All production costs are assumed to be
incurred at the beginning of each calendar year.
The sale price of each car will be £12,600 during 2016 and will also increase by 4%
each year with the first increase occurring in 2017. All revenue from sales is assumed
to be received at the end of each calendar year.
(i) Calculate the discounted payback period at an effective rate of interest of 9%

per annum. [9]
(ii) Without doing any further calculations, explain whether the discounted
payback period would be greater than, equal to, or less than the period
calculated in part (i) if the effective rate of interest were substantially less than
9% per annum. [2]
[Total 11]
9 A fixed-interest security pays coupons of 8% per annum half yearly on 1 January and
1 July. The security will be redeemed at par on any 1 January from 1 January 2017 to
1 January 2022 inclusive, at the option of the borrower.
An investor purchased a holding of the security on 1 May 2011, at a price which gave
him a net yield of at least 6% per annum effective. The investor pays tax at 30% on
interest income and 25% on capital gains.
On 1 April 2013 the investor sold the holding to a fund which pays no tax at a price to
give the fund a gross yield of at least 7% per annum effective.
(i) Calculate the price per £100 nominal at which the investor bought the security.
[5]
(ii) Calculate the price per £100 nominal at which the investor sold the security.
[3]
(iii) Show that the effective net yield that the investor obtained on the investment
was between 8% and 9% per annum. [6]
[Total 14]

10 A loan is repayable by annual instalments in arrear for 20 years. The initial
instalment is £5,000, with each subsequent instalment decreasing by £200.
The effective rate of interest over the period of the loan is 4% per annum.
(i) Calculate the amount of the original loan. [3]
(ii) Calculate the capital repayment in the 12th instalment. [3]
After the 12th instalment is paid, the borrower and lender agree to a restructuring of
the debt.
The £200 reduction per year will no longer continue. Instead, future instalments will
remain at the level of the 12th instalment and the remaining term of the debt will be
shortened. The final payment will then be a reduced amount which will clear the
debt.
(iii) (a) Calculate the remaining term of the revised loan.

(b) Calculate the amount of the final reduced payment.
(c) Calculate the total interest paid during the term of the loan.
[8]
[Total 14]
END OF PAPER
CT1 A2013–6
EXAMINERS’ REPORT

Core Technical
Introduction
The report is written based on the legislative and regulatory context pertaining to the date that
the examination was set. Candidates should take into account the possibility that
circumstances may have changed if using these reports for revision.
D C Bowie
July 2013

Subject CT1 (Financial Mathematics Core Technical) – April 2013 – Examiners’ Report
This paper proved to be marginally more challenging than other recent papers and the general
performance was of a slightly lower standard compared with the previous April exams. Well-
prepared candidates scored well across the whole paper. As in previous diets, questions that
required an element of explanation or analysis, such as Q1(iii) and Q4(ii) were less well
answered than those that just involved calculation. This is an area to which attention should
be paid. Candidates should note that it is important to explain and show understanding of the
concepts and not just mechanically go through calculations.
Page 2
1 (i) TWRR, i , is given by:
1.9 0.8
× = 1 + i ⇒ i = 0.169 or 16.9% p.a.
1.3 1.9 − 0.9
(ii) MWRR, i , is given by:
3
1.3 × (1 + i ) − 0.9 × (1 + i )12 = 0.8
Then, we have:
i = 30% ⇒ LHS = 0.729 ⎫ ⎛ 0.8 − 0.729 ⎞

⎬ ⇒ i ≈ 0.3 + ( 0.4 − 0.3) × ⎜ ⎟ = 0.36
i = 40% ⇒ LHS = 0.841 ⎭ ⎝ 0.841 − 0.729 ⎠
or 36% p.a.
(iii) MWRR is higher as fund performs much better before the cash outflow than
after. As the fund is smaller after 1 October 2012, the effect of the poor
investment performance is less significant.
The calculations were performed well but the quality of the explanations in part (iii) was
often poor. A common error was to cite the large withdrawal itself as the reason for the
superior MWRR.
2 (i) (a) Options – holder has the right but not the obligation to trade.
Futures – both parties have agreed to the trade and are obliged to do so.
(b) Call Option – right but not the obligation to BUY specified asset in the
future at specified price.
Put Option – right but not the obligation to SELL specified asset in the
future at specified price.
(ii) Assume no arbitrage.
The present value of the dividends, I , is:
I = 1.1v2.25% + 1.1v2.5%
2
= 1.1× ( 0.977995 + 0.951814 )
= 2.12279
Hence, forward price F = (10.50 − 2.12279 ) ×1.0252

= £8.8013
Page 3
3 (i) 97 = 6 a3 + 103v3
Try 9% RHS = 94.723

Try 8% RHS = 97.227
Interpolation gives
97.227 − 97
0.08 + × 0.01
97.227 − 94.723
= 0.08091
i.e. 8.09% p.a. (exact answer is 8.089%)
(ii) Let in = spot rate for term n
Then 97 = 109vi1%
⇒ i1 = 12.371% p.a.
97 = 6vi1% + 109vi22%
−2 6
109 (1 + i2 ) = 97 −
1.12371
⇒ i2 = 9.049% p.a.
Part (i) was generally well answered. Some candidates wasted time in (ii) through using
linear interpolation to solve the yield for the one year bond.
4 (i) Maximum price payable by investor is given by:
P = 0.30 ×1.05 × v9% + 0.30 × 1.052 × v9%

2
+…
⎛ 1.05 ⎞ ⎡ ⎛ 1.05 ⎞ ⎛ 1.05 ⎞ ⎤

2
= 0.30 × ⎜ ⎟ × ⎢1 + ⎜ +
⎟ ⎜ ⎟ + …⎥
⎝ 1.09 ⎠ ⎣ ⎝ 1.09 ⎠ ⎝ 1.09 ⎠ ⎦
⎛ 1.05 ⎞ 1
= 0.30 × ⎜ ⎟ × 1.05
⎝ 1.09 ⎠ 1 −
1.09
Page 4
⎛ 1.05 ⎞ 1.09 1.05

= 0.30 × ⎜ ⎟× = 0.30 ×
⎝ 1.09 ⎠ 0.09 − 0.05 0.09 − 0.05
= £ 7.875
(ii) (a) Increasing the expected rate of dividend growth, g , will increase the
maximum price that the investor is prepared to pay to purchase the
share since the dividend income is expected to be higher.
(b) An increase in the expected rate of future price inflation is likely to

lead to an increase in both the expected rate of dividend growth (as
nominal level of profits should increase in line with inflation) and the
nominal return required from the investment (as the investor is likely
to want to maintain the required real return).
Thus, the maximum price that the investor is prepared to pay will be
(largely) unchanged – in fact, it will increase slightly due to (1 + g)
term in numerator.
(c) If the investor is more uncertain about the rate of future dividend
growth (whilst the expected dividend growth is unchanged), then the
required return, i, is likely to be increased to compensate for the
increased uncertainty.
Thus, the maximum price that the investor is prepared to pay will
reduce.
Part (i) was generally well answered although common errors included adding an extra 30
pence dividend at the start or to assume that the first dividend was payable immediately.
The examiners expected candidates to find part (ii) challenging and this was indeed the case
with very few candidates scoring full marks. In (ii)(b) full marks were awarded for a
reasoned argument that led to a final answer of either an increase or no change in the price.
In general, some credit was given for valid reasoning even if the final conclusion was
incorrect.
5 (i) Accumulated value at time 10 is:
⎛ 10 ⎞ ⎛ 10 ⎞
100 × exp ⎜ ∫ δ ( t ) dt ⎟ + 50 × exp ⎜ ∫ δ ( t ) dt ⎟
⎜ ⎟ ⎜ ⎟
⎝0 ⎠ ⎝7 ⎠
⎛6 10 ⎞ ⎛ 10 ⎞
= 100 × exp ⎜ ∫ 0.1 − 0.005t dt + ∫ 0.07dt ⎟ + 50 × exp ⎜ ∫ 0.07dt ⎟
( )
⎜ ⎟ ⎜ ⎟
⎝0 6 ⎠ ⎝7 ⎠
( t =6
) (
= 100 × exp [ 0.1t − 0.0025t 2 ]t =0 + [ 0.07t ]t =6 + 50 × exp [ 0.07t ]t =7
t =10 t =10
)
Page 5
= 100 × exp ([ 0.6 − 0.09] + 0.28 ) + 50 × exp ( 0.21)
= 220.34 + 61.68
= £ 282.02
(ii) Present value at time 0 is:
15
= ∫ ρ ( t ) v ( t ) dt
12
15 ⎛ t ⎞
∫ 50e × exp ⎜ − ∫ δ ( s ) ds ⎟ dt
0.05t
=
⎜ ⎟
12 ⎝ 0 ⎠
15 ⎛ ⎡6 t ⎤⎞
∫ ×
⎜ ⎢∫ ∫
⎜ − ⎢ ( 0.1 − 0.005s ) ds + 0.07 ds ⎥ ⎟ dt
0.05t
= 50 e exp
12 ⎝ ⎣0 6 ⎥⎦ ⎟⎠
( )
15
⎡[ 2 ]s =6 [ s =t ⎤
∫ × − − s =0 + 0.07 s ]s =6 ⎦ dt
0.05t
= 50e exp ⎣ 0.1s 0.0025 s
12
15
= ∫ 50e
0.05t
× exp ( − [ 0.51 + ( 0.07t − 0.42 )]) dt
12
15
= ∫ 50e
0.05t
× e−0.09−0.07t dt
12
15
−0.09
= 50e × ∫ e −0.02t dt
12
t =15
−0.09 ⎡ e−0.02t ⎤
= 50e ×⎢ ⎥
⎣ −0.02 ⎦t =12
= 2,500e −0.09 × ( e −0.24 − e −0.30 )
= £ 104.67
Page 6
6 (i) j = 0.05 × 0.2 + 0.07 × 0.6 + 0.09 × 0.2
= 0.07
⇒ mean accumulation = 10,000 × (1 + j)15
= 10,000 × (1.07)15
= £27,590.32
(ii) s2 = 0.052 × 0.2 + 0.072 × 0.6 + 0.092 × 0.2 – 0.072
= 0.00506 – 0.00490
= 0.00016
Var (accumulation) = 10,0002{(1 + 2j + j2 + s2)15 – (1 + j)30}
= 10,0002 {1.1450615 – 1.0730}
= 1,597,283.16
SD (accumulation) = 1597283.16 = £1, 263.84
(iii) (a) By symmetry j = 0.07 (as in (i))
Hence, mean (accumulation) will be the same as in (i) (i.e.

£27,590.32).
The spread of the yields around the mean is lower than in (i). Hence,
the standard deviation of the accumulation will be lower than
£1,263.84.
(b) Mean (accumulation) < £27,590.32 since the investment is being

accumulated over a shorter period.
SD (accumulation) < £1,263.84 since investing over a shorter term

than in (i) will lead to a narrower spread of possible accumulated
amounts.
In part (i) some candidates misread the question and assumed the yield was fixed for the
whole ten years rather than varying each year.
Page 7
7 (i) Need VA (i ) = VL (i ) with i = 0.08

VL(i) = 6v8 + 11v15
VA(i) = Xv5 + Yv20
Need VA′ (i ) = VL′ (i ) with i = 0.08

VL′ = −48v9 − 165v16
VA′ = − 5Xv6 – 20Y v21
Thus we have to solve simultaneous equations:
(a) 6v8 + 11v15 = Xv5 + Yv20

(b) −48v9 − 165v16 = − 5Xv6 – 20Y v21
Taking 5 times (a) + (1+i) times (b) we get
−18v8 − 110v15 = −15Yv 20

18 (1 + i ) + 110 (1 + i )
12 5
⇒Y =
15
⇒ Y = 13.79688
Substitute back in (a) to get X = 5.50877
Hence the values of the zero-coupon bonds are £5.50877 million and
£13.79688 million.
(ii) We need to check that the third condition is satisfied:
VA′ = −5 Xv 6 − 20Yv 21
⇒ VA′′ = 30 Xv 7 + 420Yv 22
⇒ VA′′ (0.08) = 30 × 5.50877 × 1.08−7 + 420 ×13.79688 ×1.08−22
= 1162.31
VL′ = −48 v9 − 165 v16

⇒ VL′′ = 432 v10 + 2640 v17
⇒ VL′′(0.08) = 432 × 1.08−10 + 2640 × 1.08−17
= 913.61
Therefore VA′′ (0.08) > VL′′(0.08)
Thus the third condition is satisfied.
[Or note that since the assets have terms of 5 years and 20 years and the liabilities
have terms of 8 years and 15 years, the spread of assets around the mean term is
Page 8
greater than that of the liabilities. Hence, the convexity of assets is greater than the
convexity of liabilities].
The best answered question on the paper.
8 (i) Work in £ millions
Let Discounted Payback Period from 1 January 2014 be n.
Then, considering project at the end of year n but before the outgo at the start
of year n + 1
1
− 19 − 9v 2 − 5v
(
− 6 × 9.5 v 2 + 1.04v3 + ... + (1.04 )
n −3 n −1
v )
( v )≥0
n −3 n
+ 6 ×12.6 v3 + 1.04v 4 + ... + (1.04 ) at 9%
⎛ ⎛ 1.04 ⎞ n−2 ⎞
⎜ 1− ⎜ ⎟ ⎟
(
Hence, 19 + 8.6204 + 4.5872 ≤ 75.6v3 − 57v 2 ) ⎜ ⎝ 1.09 ⎠
⎜ 1.04 ⎟
⎟
⎜⎜ 1 − 1.09 ⎟⎟
⎝ ⎠
⎛ ⎛ 1.04 ⎞n−2 ⎞
and RHS = 10.4013 × 21.8 × ⎜ 1 − ⎜ ⎟
⎜ ⎝ 1.09 ⎟⎠ ⎟
⎝ ⎠
n−2
32.2076 ⎛ 1.04 ⎞
Hence, ≤ 1− ⎜ ⎟
10.4013 × 21.8 ⎝ 1.09 ⎠
n− 2
⎛ 1.04 ⎞
⇒⎜ ⎟ ≥ 0.85796
⎝ 1.09 ⎠
⎛ 1.04 ⎞
⇒ ( n − 2 ) log ⎜ ⎟ ≥ log 0.85796
⎝ 1.09 ⎠
−0.06653
⇒ n−2≥ = 3.262
−0.02039
⇒ n ≥ 5.262
But sales are only made at the end of each calendar year.
⇒ DPP = 6 years
Page 9
(ii) The DPP would be shorter using an effective rate of interest less than 9% p.a.
This is because the income (in the form of car sales) does not commence until
a few years have elapsed whereas the bulk of the outgo occurs in the early
years. The effect of discounting means that using a lower rate of interest has a
greater effect on the value of the income than on the value of the outgo
(although both values increase). Hence the DPP becomes shorter.
In part (i), many candidates valued the total outgo for the whole production run and then
attempted to find when the present value of income exceeded this. The working of many
marginal candidates was difficult to follow and it was not clear to the examiners what the
candidates were attempting to do.
× 0.7 = 0.056 < i ( 2 ) = 0.059126

D 0.08
9 (i) (1 − t1 ) =
R 1 6%
⇒ There is a capital gain and assume redeemed as late as possible.
Let P = Price at 1/5/11 per £100 nominal
( 2)
P = ⎡0.7 × 8 a + 100v11 − 0.25 (100 − P ) v11 ⎤ × (1 + i ) 12
4
⎣⎢ 11 ⎦⎥
⇒ P = 5.6 ×1.014782 × 7.8869 × (1.06 )

4 10 812 10 812
12
+ 75v + 0.25 Pv
45.6985 + 40.2839
⇒P =
10 812
1 − 0.25v
= £99.319
D ( 2)
(ii) = 0.08 > i7% = 0.068816
R
⇒ Assume redeemed as soon as possible
(2
4 )
Sale Price per £100 nominal = 8 a( ) + 100v 4 × (1 + i ) 12
3
= ( 8 ×1.017204 × 3.3872 + 100 × 0.76290 ) × (1.07 )

3
12
= £ 105.625
(iii) CGT is payable of (105.625 − 99.319 ) × 0.25

= £1.5765
Page 10
Equation of value:
+ (105.625 − 1.5765 ) v
2 8 12 1812 11112
99.319 = 0.7 × 4 × v 12 + 0.7 × 4 × v
+ 0.7 × 4 × v 12 + 0.7 × 4 × v
12
( 2)
⇒ 99.319 = (1 + i ) 12 × 5.6 a + 104.0485v 12
4 111
2
4 11112
At 8%, RHS is 1.08 12 × 5.6 ×1.019615 ×1.7833 + 104.0485v
= 100.226
At 9% RHS is (1.09 )
4 11112
12
× 5.6 ×1.022015 ×1.7591 + 104.0485v
= 98.568
and since 98.568 < 99.319 < 100.226, the net yield is between 8% and 9% p.a.
Many candidates struggled with the four month adjustment in part (i). Common errors
included:
• ignoring the adjustment completely.

• discounting the present value of payments by four months rather than accumulating.
• adjusting the price at the end of the calculations (which does not allow for CGT
correctly).
In part (iii) some candidates wasted time by trying to solve the yield exactly rather than just
show that 8% was too low and 9% too high.
10 (i) Original amount of loan is:
L = 5, 000v + 4,800v 2 + 4, 600v3 + … + 1, 200v 20
( ) (
= 5, 200 × v + v 2 + … + v 20 − 200 × v + 2v 2 + … + 20v 20 )
= 5, 200a20 − 200 ( Ia )20
= 5, 200 × 13.5903 − 200 × 125.1550
= £45, 638.56
(ii) Amount of 12th instalment is £2,800.
Loan o/s after 11th instalment is given by PV of future repayments:
L11 = 2,800v + 2, 600v 2 + 2, 400v3 + … + 1, 200v9

= 3, 000a9 − 200 ( Ia )9
= 3, 000 × 7.4353 − 200 × 35.2366
= £15, 258.58
Then, interest component of 12th instalment is: 0.04 × 15, 258.58 = £610.34 .
Page 11
Hence, capital repaid in 12th instalment is 2,800 − 610.34 = £2,189.66 .
(iii) (a) Then, after 12th instalment, loan o/s is
15, 258.58 − 2,189.66 = £13, 068.92 .
This will be repaid by level instalments of £2,800.
Thus, remaining term of loan is n given by:
13, 068.92 ≤ 2,800 × an4% ⇒ an4% ≥ 4.6675 ⇒ n = 6
i.e. remaining term is 6 years (i.e. loan is repaid by time 18)
(b) We need to find reduced final payment, R , such that:
13, 068.92 = 2,800 × a54% + Rv4%

6
⇒ 0.79031R
= 13, 068.92 − 2,800 × 4.4518 ⇒ R = £764.11
(c) Total amount of interest paid is given by:
5, 000 + 4,800 + 4, 600 + … + 2,800 + 5 × 2,800 + 764.11 − 45, 638.56

= £15, 925.55
In part (ii) the most common error was to not round n up, i.e. quoting a non-integer number
of years for the revised loan. Part (iii) was answered poorly with candidates often not
correctly allowing for the payments prior to the change in payment schedule.
Page 12
EXAMINERS’ REPORT

Core Technical
Introduction
D C Bowie
December 2013

Subject CT1 (Financial Mathematics Core Technical) – September 2013 – Examiners’ Report
This paper proved to have some questions where the vast majority of candidates scored well
and others where many candidates found challenging. Well-prepared candidates scored well
across the whole paper. As in previous diets, questions that required an element of
explanation or analysis, such as Q1(ii), Q8(iv), Q10(iii) and Q11(v) were less well answered
than those that just involved calculation. This is an area to which attention should be paid.
Candidates should note that it is important to explain and show understanding of the concepts
and not just mechanically go through calculations.
Page 2
0.045
1 (i) (a) =d = 0.043062
= 4.3062%
1.045
(1 − d (12)12 ) =
−1
(b) (1.045) 12
d (12)
∴1 − =0.99634
12
∴ d (12) =
0.043936 or 4.3936%
4
 i (4) 
(c) 1 +  =
1.045
 4 
 i (4) 
∴ 1 + =1.011065
 4 

∴i (4)
=
0.044260 or 4.4260%
(d) 1.0455 = 1.24618
∴ five-yearly effective rate is 24.618%
(ii) The answer to (i)(b) is bigger than the answer to (i)(a) because the rate of
discount convertible monthly is applied each month to a smaller (already
discounted) sum of money. As such, in order to achieve the same total amount
of discounting the rate has to be slightly more than one twelfth of the annual
rate of discount. [An answer relating to the concept of interest payable in
advance would also be acceptable].
The calculations were performed well but the quality of the explanations in part (ii) was often
(1 )
( 1 )
5
poor. A common error in (i)(d) was to state the answer as i rather than
i 5
.
1⁄ 5
2 Present value of dividend = 0.1×1.04−0.5 =

0.09806
Value of forward is (1.8 − 0.09806 ) ×1.040.75 =

£1.75275
Page 3
3 (i) Work in half years.
P = 2a20 + 100v 20 @1 1 2 %
= 2× 17.1686+100× 0.74247
= £108.584
91
(ii) P = (2 × 0.75a20 + 100v 20 )(1.015) 182.5
91
= (2×0.75×17.1686+100×0.74247)× (1.015) 182.5
= £100.7452
Part (i) was answered well although some candidates assumed an annual effective rate of
3%. In part (ii) many candidates did not deal with the 91 days elapsed duration – discounting
instead of accumulating the 10-year bond price and/or assuming that 91 days equated to a
quarter of a year.
4 (i) The investor pays a purchase price at outset.
The investor receives a series of coupon payments and a capital payment at

maturity
The coupon and capital payments are linked to an index of prices (possibly
with a time lag)
[Time lag does not have to be mentioned].
(ii) The investor pays a purchase price at outset
Shareholders are paid dividends. These are not fixed but declared out of
profits.
Dividends may be expected to increase over time ….
….but may cease if the company fails.
There is a high degree of uncertainty with regard to future cash flows.
No maturity date
Would receive a sale price on the sale of the shares
Generally poorly answered with many candidates just writing down all characteristics they
knew about these assets rather than concentrating on the cashflows. Many candidates
omitted mention of the initial purchase price in each part.
Page 4
106
5 (i) The return from the bonds issued by Country A is: − 1 =0.049505
101
The expected cash flows from the bonds from Country B are:
0.1 × 0 + 0.2 × 100 + 0.3 × 50 + 0.4 × 106 = 77.4
The price to provide the same expected return is P such that:
77.4
=P = €73.749
1.049505
(ii) The gross redemption yield from the bond is such that:
73.749 × (1 + i ) =
106
∴ i =43.731%
(iii) The risk is higher for Country B’s bond. Although the gross redemption yield
is such that the expected returns are equal, the investor may want a higher
expected return to compensate for the higher risk.
Many candidates had trouble with part (ii) not recognising that the gross redemption yield
calculation will not include any allowance for default.
6 Divide the number of cars by 100 to obtain the share due to the pension fund
(
PV of income = 365 × 400 a1 +365 × 500 a1 v ×1.1× 1 + 1.012 v + 1.014 v 2 + ...... + 1.0136 v18 )
i i  1 − 1.0138 v19 
= 365 × 400 a1 + 365 × 500 a1 v ×1.1× 
δ δ  1 − 1.012 v 
 
= 365 × 400 × 1.039487 × 0.92593

 1 − 1.45953 × 0.23171 
+365 × 500 × 1.039487 × 0.92593 × 0.92593 × 1.1 ×  
 1 − 1.0201 × 0.92593 
= 140,523 + 178,907 × 11.93247
= 140,523 + 2,134,801 = 2,275,324 so NPV = £275,324
Candidates made a variety of errors in this question often ignoring one or more parts of the
scenario (e.g. pension fund’s 1% share of the project, the fact that daily vehicle numbers
were given in the question, 1% increases in both vehicle numbers and tolls from the second
year). Nevertheless, candidates who set out their workings clearly and logically often scored
the majority of the available marks.
Page 5
7 (i) (1 + it) ~ lognormal (μ, σ2)
ln(1 + it ) ~ N (µ, σ2 )
5
ln ∏ (1 + it ) = ln(1 + it ) + ln(1 + it ) + L + ln(1 + it )
t =1
~ N (5µ,5σ2 ) by independence
5
∴ ∏ (1 + it ) ~ lognormal (5µ,5σ2 )
t =1
 σ2 
E (1 +=
it ) exp  µ + =  1.055
 2
 
it ) exp(2µ + σ2 ) exp(σ2 ) =
Var(1 += − 1 0.042
 
0.042 
=
1.055 2  ( )
exp σ2 − 1 ∴σ

= 2
0.0014365
 0.0014360 
exp  µ + =  1.055 ⇒
 2 
0.0014365
=µ ln1.055 − = 0.052823
2
5µ = 0.264113
5σ2 = 0.007182.
Let S5 be the accumulation of one unit after five years:
 5σ2   0.007182 
E ( S5 ) = exp =5×µ +  exp  0.264113 + 
 2   2 

= 1.30696
 ( )
Var( S5 ) = exp(2 × 5µ + 5σ2 ) exp 5σ2 − 1

= exp(2 × 0.264113 + 0.007182).(exp 0.007182 − 1)
Page 6
= exp 0.53541 (exp 0.007182 − 1)
= 0.012313
Mean value of the accumulation of premiums is
7,850,000 × 1.30696 = £10,259,636.
Standard deviation of the accumulated value of the premiums is
7,850, 000 × 0.012313 =

£871, 061
Alternatively:
Let it be the (random) rate of interest in year t . Let S5 be the accumulation of a

single investment of 1 unit after five years:
E ( S5 ) = E (1 + i1 )(1 + i2 ) K (1 + i5 ) 
E ( S5 ) = E [1 + i1 ] E [1 + i2 ]K E [1 + i5 ] as {it } are independent
E [it ] = 0.055
∴ E ( S5 ) = (1.055 ) = 1.30696
5
( )
E S52 = E  (1 + i1 )(1 + i2 ) K (1 + i5 )  

2

E (1 + i1 ) E (1 + i2 ) K E (1 + i5 ) (using independence)
2 2 2
=
( ) ( ) (
= E 1 + 2i1 + i12 E 1 + 2i2 + i22 K E 1 + 2i5 + i52 )
( )
5
= 1 + 2 × 0.055 + 0.042 + 0.0552
as E ii2  =V [it ] + E [it ] =0.042 + 0.0552

2
 
( )
5
∴ Var [ S5 ] = 1 + 2 × 0.055 + 0.042 + 0.0552 − (1.055 )
10
∴ 1.1146255 − (1.055 ) 0.0123128 10

= =
Page 7
7,850,000 × 1.30696 = £10,259,636.
7,850, 000 × 0.012313 =

£871, 061
(ii) If the company invested in fixed-interest securities, it would obtain a

guaranteed accumulation of £7,850,000 (1.04)5 = £9,550,725. In one sense,
there is a 100% probability that a loss will be made and therefore the policy is
unwise. The “risky” investment strategy leads to an expected profit. On the
other hand, the standard deviation of the accumulation from the risky
investment strategy is £871,061. Whilst there is a chance of an even greater
profit from this strategy, there is also a chance of a more considerable loss
than from investing in fixed-interest securities.
A poorly answered questions with many candidates not including enough derivation of the
required results in part (i). Some candidates mixed their answers between the two methods
given above e.g. they calculated µ and σ2 for the log normal route, then used these in the
alternative method for the mean and variance of it. Other candidates just used 0.055 and
.042 as their values of µ and σ2 .
8 (i) Purchase price of the annuity (working in half-years)
5, 000a (6) calculated at i = 2%

50
i
= 5, 000 (6)
a50
i
i = 0.02
i(6) = 0.019835
a50 = 31.4236
0.02
Purchase price = 5, 000 × × 31.4236
0.019835
= £158,422
Page 8
Individual needs to invest X such that: (working in years)
X 1.0520 = 158,422
1.0520 = 2.653297
158, 422
=
∴X = £59, 708
2.653297
(ii) Real return is j such that:
158, 422 143

=
59, 708 ×
(1 + j ) 20 340
158, 422 143

∴ (i + j ) 20 = ×
59, 708 340
=1.11595
∴j = 0.550%
(iii) The amount of the capital gain is:
158,422 – 59,708 = 98,714
Tax = 0.25 × 98,714 = 24,679
Proceeds of investment = 133,744
Net real return is j ′ such that:
133, 744 143

=
59, 708 ×
(1 + j ′) 20 340
133, 744 143

∴ (1 + j ′) 20 = ×
59, 708 340
= 0.942106
∴ j ′ = −0.2977%
(iv) The capital gains taxed has taxed the nominal gain, part of which is merely to
compensate the investor for inflation. The tax has therefore reduced the real
value of the investor’s capital and led to a negative real return.
Parts (i) and (ii) were generally answered well but many candidates struggled with the
calculation of the capital gain in part (iii) not recognising that this would be based on money
values.
Page 9
9 (i) PV is:
400v + 380v 2 + 360v3 + L + 120v5
420 a15 − 20 ( Ia )15 @ 4%
= 420 × 11.1184 - 20 × 80.8539
= 4,669.728 – 1,617.078 = £3,052.65.
(ii) Interest component:
= 0.04 × 3,052.65 = £122.106
Capital component = 400 – 122.106

= £277.894
(iii) Seven repayments remain and the PV of the remaining payments is:
240v + 220v 2 + L + 120 v 7
260 a7 − 20 ( Ia )7 @ 4%
= 260 × 6.0021 − 20 × 23.0678 = £1, 099.19
The loan is written down to: 0.5 × 1,099.19

= £549.595
The present value of the new repayment is:
( X − 2 ) a10 + 2( Ia )10 @8%
∴ 549.595= ( X − 2 ) 6.7101 + 2 × 32.6869

549.595 − 2 × 32.6869
=∴X −2 = 72.163
6.7101
∴X =
£74.16
The best answered question on the paper although some candidates, when calculating the
outstanding loan in part (iii), stated that the repayment in year 8 was £420. Some candidates
also used the incorrect formula Xa10 + 2( Ia )10 for the repayment in part (iv).
Page 10
7
∫ 0.05+0.002t dt
10 (i) (a) e0
 0.002t 2  7
0.05t + 
 2 
= e 0
0.002 × 49
= exp [ 0.05 × 7 ] +
2
= exp (0.399) = 1.490331
6
∫ 0.05+0.002t dt
(b) e 0
 0.002×36 
0.05×6+ 2 
= e
= exp (0.336) = 1.399339
1.490331
(c) = 1.06503
1.399339
(ii) (a) Let spot rate = i7
(1 + i7 )7 =
1.490334
⇒ i7 =
5.8656% p.a. effective
(b) (1 + i6 )6 =
1.39934
∴ i6 =
5.7598% p.a. effective
(c) From (i) (c) 6.503% per annum effective.
(iii) The forward rate is the rate of interest in the seventh year. The spot rate, in
effect, is the rate of interest per annum averaged over the seven years (a form
of geometric average). As the force of interest is rising the rate of interest in
the seventh year must be higher than the rate averaged over the full seven year
period.
Page 11
t
− ∫ 0.05+ 0.002 s ds
(iv) v(t ) = e 0
 0.002 s 2  t
− 0.05 s + 
= e 
2 
0
= e−0.05t −0.001t
2
We require
10
∫ ρ(t )v(t )dt

3
30 e −0.01t
10
∫ .e−0.05t .e −0.001t dt
2
=
e−0.001t
2
3
10
30 ∫ e−0.06t dt
3
30  −0.06t 10
e
−0.06  3
30  −0.6 −0.18 
= e −e
−0.06  
= −500(0.548812 − 0.83527)
=143.229
The calculations were well-done but only the best candidates clearly explained their
reasoning in part (iii).
11 (i) Present value of liabilities annuity
10 a40 at 4% a40 = 19.7928
= 10 × 19.7928 = £197.928m
(ii) Call 10 year security “security A” and five year security “security B”.
We need to calculate the PV of £100 nominal for each of security A and

security B
Page 12
P.V of £100 nominal of A is:
5a10 + 100v10 @4%
= =
a10 8.1109 v10 0.67556
∴PV = 5×8.1109 + 67.556 = 108.1105
P.V of £100 nominal of B is:
10 a5 + 100v5 @ 4%
= =
a5 4.4518 v5 0.82193
∴ PV = 44.518 + 82.193 = 126.711
£98.964m, is invested in each security.
98,964, 000
×100 per £100 nominal of A is bought.
108.1105
= £91,539,674 nominal
98,964, 000
×100 per £100 nominal of B is bought
126.711
= £78,102,138 nominal
[other ways of expressing units are okay, but marks will be deducted if units
are not correct]
(iii) Duration of the liabilities
=
∑ tct vt
∑ ct vt
40
Numerator = ∑10 t vt (in £ m)
t =1
= 10( Ia ) 40 =
10 × 306.3231 =
3063.231 at 4% p.a. effective
∴ Duration = 3063.231/197.928 = 15.48 years
Page 13
(iv) Numerator of duration is:
(5( Ia )10 + 10 ×100 v10 ) × 915,396.74
+(10( Ia )5 + 5 ×100 v5 ) × 781, 021.38
Following the same reasoning as for the calculation of the duration of the
annuity payments, adding the capital repayment and multiplying by the
number of units of £100 nominal bought.
( Ia )10 = 41.9922
v10 = 0.67556
( Ia )5 = 13.0065
v5 = 0.82193
= (5 × 41.9922 + 10 × 100 × 0.67556) × 915,396.74
+(10 × 13.0065 + 5 × 100 × 0.82193) × 781, 021.38
= 810, 603, 000 + 422,554, 000
= 1, 233,157, 000
∴Duration = 1,233,157,000/197,928,000
= 6.23 years
(v) The duration (and therefore the volatility) is greater for the liabilities than for
the assets. As a result, when interest rates fall, the present value of the
liabilities will rise by more than the present value of the assets and so a loss
will be made.
Many candidates wrongly assumed that the same nominal amounts were bought of each asset
rather than each asset amount having the same present value. This assumption made the
calculations in part (ii) somewhat easier and the marks awarded in this part took this into
account. Part (iii) was answered well. The explanations in part (v) were often poorly stated
although time pressures at the end of the paper may have contributed to this.
Page 14
EXAMINATION
23 September 2013 (pm)

Core Technical
booklet.
supervisor.
question paper.

1 The rate of interest is 4.5% per annum effective.
(i) Calculate:
(a) the annual effective rate of discount.

(b) the nominal rate of discount per annum convertible monthly.
(c) the nominal rate of interest per annum convertible quarterly.
(d) the effective rate of interest over a five year period.
[5]
(ii) Explain why your answer to part (i)(b) is higher than your answer to part
(i)(a). [2]
[Total 7]
2 A nine-month forward contract is issued on 1 March 2012 on a share with a price of

£1.80 at that date. Dividends of 10p per share are expected on 1 September 2012.
Calculate the forward price at issue assuming a risk-free rate of interest of 4% per
annum effective and no arbitrage. [3]
3 A fixed-interest security pays coupons of 4% per annum, half-yearly in arrear and will
be redeemed at par in exactly ten years.
(i) Calculate the price per £100 nominal to provide a gross redemption yield of
3% per annum convertible half-yearly. [2]
(ii) Calculate the price, 91 days later, to provide a net redemption yield of 3% per
annum convertible half-yearly if income tax is payable at 25%. [2]
[Total 4]
4 Describe the characteristics of the cash flows that are paid and received in respect of:
(i) an index-linked security. [2]

(ii) an equity. [3]
[Total 5]
CT1 S2013–2
5 An investor is considering the purchase of two government bonds, issued by two
countries A and B respectively, both denominated in euro.
Both bonds provide a capital repayment of €100 together with a final coupon payment
of €6 in exactly one year. The investor believes that he will receive both payments
from the bond issued by Country A with certainty. He believes that there are four
possible outcomes for the bond from Country B, shown in the table below.
Outcome Probability
No coupon or capital payment 0.1

Capital payment received, but no coupon payment received 0.2
50% of capital payment received, but no coupon payment received 0.3
Both coupon and capital payments received in full 0.4
The price of the bond issued by Country A is €101.
(i) Calculate the price of the bond issued by Country B to give the same expected
return as that for the bond issued by Country A. [3]
(ii) Calculate the gross redemption yield from the bond issued by Country B
assuming that the price is as calculated in part (i). [1]
(iii) Explain why the investor might require a higher expected return from the bond
issued by Country B than from the bond issued by Country A. [2]
[Total 6]
6 A pension fund is considering investing in a major infrastructure project. The fund

has been asked to make an investment of £2m for a 1% share in revenues from
building a road. No other costs will be incurred by the pension fund. The following
revenues are expected to arise from the project:
In the first year, 40,000 vehicles a day will use the road, each paying a toll of £1.
In the second year, 50,000 vehicles a day will use the road, each paying a toll of
£1.10.
In the third year, both the number of vehicles using the road and the level of tolls will
rise by 1% from their level in the second year. They will both continue to rise by 1%
per annum compound until the end of the 20th year.
At the end of the 20th year, it is assumed that the road has no value as it will have to
be completely rebuilt.
You should assume that all revenue is received continuously throughout the year and
that there are 365 days in all years.
Calculate the net present value of the investment in the road at a rate of interest of 8%
per annum effective. [10]

7 An insurance company has just written contracts that require it to make payments to
policyholders of £10 million in five years’ time. The total premiums paid by
policyholders at the outset of the contracts amounted to £7.85 million. The insurance
company is to invest the premiums in assets that have an uncertain return. The return
from these assets in year t, it, has a mean value of 5.5% per annum effective and a
standard deviation of 4% per annum effective. (1+it) is independently and
lognormally distributed.
(i) Calculate the mean and standard deviation of the accumulation of the
premiums over the five-year period. You should derive all necessary formulae.
[Note: You are not required to derive the formulae for the mean and variance
of a lognormal distribution.] [9]
A director of the insurance company is concerned about the possibility of a

considerable loss from the investment strategy suggested in part (i). He therefore
suggests investing in fixed-interest securities with a guaranteed return of 4 per cent
(ii) Explain the arguments for and against the director’s suggestion. [3]
[Total 12]
8 Mrs Jones invests a sum of money for her retirement which is expected to be in 20
years’ time. The money is invested in a zero coupon bond which provides a return of
5% per annum effective. At retirement, the individual requires sufficient money to
purchase an annuity certain of £10,000 per annum for 25 years. The annuity will be
paid monthly in arrear and the purchase price will be calculated at a rate of interest of
4% per annum convertible half-yearly.
(i) Calculate the sum of money the individual needs to invest at the beginning of
the 20-year period. [5]
The index of retail prices has a value of 143 at the beginning of the 20-year period and
340 at the end of the 20-year period.
(ii) Calculate the annual effective real return the individual would obtain from the
zero coupon bond. [2]
The government introduces a capital gains tax on zero coupon bonds of 25 per cent of
the nominal capital gain.
(iii) Calculate the net annual effective real return to the investor over the 20-year
period before the annuity commences. [3]
(iv) Explain why the investor has achieved a negative real rate of return despite
capital gains tax only being a tax on the profits from an investment. [2]
[Total 12]
CT1 S2013–4
9 A bank makes a loan to be repaid by instalments paid annually in arrear. The first
instalment is £400, the second is £380 with the payments reducing by £20 per annum
until the end of the 15th year, after which there are no further repayments. The rate of
interest charged is 4% per annum effective.
(i) Calculate the amount of the loan. [3]
(ii) Calculate the capital and interest components of the first payment. [2]
At the beginning of the ninth year, the borrower can no longer make the scheduled
repayments. The bank agrees to reduce the capital by 50 per cent of the loan
outstanding after the eighth repayment. The bank requires that the remaining capital
is repaid by a 10-year annuity paid annually in arrear, increasing by £2 per annum.
The bank changes the rate of interest to 8% per annum effective.
(iii) Calculate the first repayment under the revised loan. [5]
[Total 10]
given by the formula:
δ(t) = 0.05 + 0.002t
Calculate the accumulated value of a unit sum of money:
(i) (a) accumulated from time t = 0 to time t = 7.

(b) accumulated from time t = 0 to time t = 6.
(c) accumulated from time t = 6 to time t = 7.
[5]
(ii) Calculate, using your results from part (i) or otherwise:
(a) the seven-year spot rate of interest per annum from time t = 0 to time
t = 7.
(b) the six-year spot rate of interest per annum from time t = 0 to time
t = 6.
(c) f6,1 where f6,1 is the one-year forward rate of interest per annum from
time t = 6. [3]
(iii) Explain why your answer to part (ii)(c) is higher than your answer to part
(ii)(a). [2]
(iv) Calculate the present value of an annuity that is paid continuously at a rate of
2
30e−0.01t +0.001t units per annum from t = 3 to t = 10. [5]
[Total 15]

11 A pension fund has liabilities to meet annuities payable in arrear for 40 years at a rate
of £10 million per annum.
The fund is invested in two fixed-interest securities. The first security pays annual
coupons of 5% and is redeemed at par in exactly ten years’ time. The second security
pays annual coupons of 10% and is redeemed at par in exactly five years’ time. The
present value of the assets in the pension fund is equal to the present value of the
liabilities of the fund and exactly half the assets are invested in each security. All
assets and liabilities are valued at a rate of interest of 4% per annum effective.
(i) Calculate the present value of the liabilities of the fund. [1]
(ii) Calculate the nominal amount held of each security purchased by the pension
fund. [6]
(iii) Calculate the duration of the liabilities of the pension fund. [3]
(iv) Calculate the duration of the assets of the pension fund. [4]
(v) Without further calculations, explain whether the pension fund will make a
profit or loss if interest rates fall uniformly by 1.5% per annum effective. [2]
[Total 16]
END OF PAPER
CT1 S2013–6
EXAMINATION
22 April 2014 (am)

Core Technical
booklet.
supervisor.
4. Attempt all 12 questions, beginning your answer to each question on a new page.
question paper.
CT1 A2014 Institute and Faculty of Actuaries

1 You are given the following information in respect of a pension fund:
Calendar Value of fund Value of fund Net cash flow

Year at 1 January at 30 June received on 1 July
2011 £870,000 £872,000 £26,000
2012 £914,000 £902,000 £27,000
2013 £953,000 £962,000 £33,000
2014 £990,000
Calculate, to the nearest 0.1%, the annual effective money-weighted rate of return
earned by the fund during the period from 1 January 2011 to 1 January 2014. [4]
2 Describe the main features of:
(a) debenture stocks.

(b) unsecured loan stocks. [5]
3 £900 accumulates to £925 in four months.
Calculate the following:
(i) the nominal rate of interest per annum convertible half-yearly [2]
(ii) the nominal rate of discount per annum convertible quarterly [2]
(iii) the simple rate of interest per annum [2]
[Total 6]
4 A company issues a loan stock bearing interest at a rate of 8% per annum payable
half-yearly in arrear. The stock is to be redeemed at 103% on any coupon payment
date in the range from 20 years after issue to 25 years after issue inclusive, to be
chosen by the company.
An investor, who is liable to income tax at 30% and tax on capital gains at 40%,
bought the stock at issue at a price which gave her a minimum net yield to redemption
of 6% per annum effective.
Calculate the price that the investor paid. [7]
CT1 A2014–2
5 On 25 October 2008 a certain government issued a 5-year index-linked stock. The
stock had a nominal coupon rate of 3% per annum payable half-yearly in arrear and a
nominal redemption price of 100%. The actual coupon and redemption payments
were index-linked by reference to a retail price index as at the month of payment.
An investor, who was not subject to tax, bought £10,000 nominal of the stock on
26 October 2012. The investor held the stock until redemption.
You are given the following values of the retail price index:
2008 ----- 2012 2013

April ----- ----- ----- 171.4
October 149.2 ----- 169.4 173.8
(i) Calculate the coupon payment that the investor received on 25 April 2013 and
the coupon and redemption payments that the investor received on
25 October 2013. [3]
(ii) Calculate the purchase price that the investor paid on 25 October 2012 if the
investor achieved an effective real yield of 3.5% per annum effective on the
investment. [4]
[Total 7]
6 An insurance company has liabilities of £10 million due in 10 years’ time and £20
million due in 15 years’ time. The company’s assets consist of two zero-coupon
bonds. One pays £7.404 million in 2 years’ time and the other pays £31.834 million
in 25 years’ time. The current interest rate is 7% per annum effective.
(i) Show that Redington’s first two conditions for immunisation against small
changes in the rate of interest are satisfied for this insurance company. [6]
(ii) Calculate the present value of profit that the insurance company will make if
the interest rate increases immediately to 7.5% per annum effective. [2]
(iii) Explain, without any further calculation, why the insurance company made a
profit as a result of the change in the interest rate. [2]
[Total 10]
7 Six months ago, an investor entered into a one-year forward contract to purchase a
non-dividend paying stock. The risk-free force of interest was 4% per annum. The
value of the stock is now 98% of its original value.
Calculate the minimum value for the risk-free force of interest at which the original
forward contract still has a positive value to the investor. [6]

8 An insurance company borrows £50 million at an effective interest rate of 9% per
annum. The insurance company uses the money to invest in a capital project that pays
£6 million per annum payable half-yearly in arrear for 20 years. The income from the
project is used to repay the loan. Once the loan has been repaid, the insurance
company can earn interest at an effective interest rate of 7% per annum.
(i) Calculate the discounted payback period for this investment. [4]
(ii) Calculate the accumulated profit the insurance company will have made at the
end of the term of the capital project. [5]
[Total 9]
9 The effective n-year spot rate of interest yn , is given by:
n
yn = 0.035 + for n = 1, 2 and 3
1000
(i) Determine the implied one-year forward rates applicable at times t = 1 and
t = 2 to four significant figures. [4]
(ii) Calculate, assuming no arbitrage:
(a) The price at time t = 0 per £100 nominal of a bond which pays annual
coupons of 4% in arrear and is redeemed at 105% per £100 nominal
after three years.
(b) The two-year par yield.

[6]
[Total 10]
10 A loan of £20,000 is repayable by an annuity payable annually in arrear for 25 years.

The annual repayment is calculated at an effective interest rate of 8% per annum and
increases by £50 each year.
(i) Calculate the amount of the first payment. [3]
(ii) Calculate the capital outstanding after the first three payments have been
made. [2]
(iii) Explain your answer to part (ii). [2]
(iv) Calculate the total amount of interest paid over the term of the loan. [3]
[Total 10]
CT1 A2014–4
11 An individual can obtain a force of interest per annum at time t , measured in years, as
⎧0.03 + 0.01t 0≤t <4

⎪
δ(t ) = ⎨0.07 4≤t <6
⎪0.09 6≤t
⎩
(i) Calculate the amount the individual would need to invest at time t = 0 in order
to receive a continuous payment stream of $3,000 per annum from time t = 4
to t = 10 . [6]
(ii) Calculate the equivalent constant annual effective rate of interest earned by the
individual in part (i). [3]
[Total 9]
12 An investor is considering investing £18,000 for a period of 12 years. Let it be the

effective rate of interest in the t th year, t ≤ 12. Assume, for t ≤ 12, that it has mean
value of 0.08 and standard deviation 0.05 and that 1 + it is independently and
lognormally distributed.
(i) Determine the distribution of S12 where St is the accumulation of £1 over t

years. [5]
At the end of the 12 years the investor intends to use the accumulated amount of the
investment to purchase a 12-year annuity certain paying:
£4,000 per annum monthly in advance during the first four years;
£5,000 per annum quarterly in advance during the second four years;
£6,000 per annum continuously during the final four years.
The effective rate of interest will be 7% per annum in years 13 to 18 and 9% per
annum in years 19 to 24 where the years are counted from the start of the initial
investment
(ii) Calculate the probability that the investor will meet the objective. [12]
[Total 17]
END OF PAPER
CT1 A2014–5
EXAMINERS’ REPORT

Core Technical
Introduction
D C Bowie
June 2014
 Institute and Faculty of Actuaries

answered well by most candidates
1 We can ignore the fund values given at 30 June.
Working in £000s:
870 1  i   26 1  i   27 1  i  2  33 1  i  2  990
3 2 12 11 1
Approximate i comes from:
870  26  27  331  i 3  990

 i  1.2%
Try 1%, LHS = 983.587
Try 2%, LHS = 1011.713
So
990  983.587
i = 0.01   0.02  0.01 
1011.713  983.587
= 0.0123
Answer = 1.2% p.a.
Well answered although many candidates ignored the instruction to give the answer to the
nearest 0.1%, and were penalised accordingly.
2 (a) Debentures
Debentures are part of the loan capital of companies.

The term “loan capital” usually refers to long-term borrowings rather than
short-term.
Payments consist of regular coupons…
…and a final redemption payment
The issuing company provides some form of security to holders of the
debenture…
…e.g. via a fixed or floating charge on the company’s assets
Debenture stocks are considered more risky than government bonds…
…and are considered less marketable than government bonds.
Accordingly the yield required by investors will be higher than for a
comparable government bond.
Page 3
(b) Unsecured loan stocks
Issued by various companies.

They are unsecured – holders rank alongside other unsecured creditors.
Yields will be higher than on comparable debentures issued by the same
company…
…to reflect the higher default risk.
This question was poorly answered despite being completely based on bookwork.
The above shows the variety of points that could be made (and not all were required for full
marks). Many marginal candidates either made no significant attempt at the question or did
not make enough distinct points.
4
2
 i 2   12
3 (i) 900  1    925
 2 
 
8
12
 i  2  12 925 i    925  8
2

 1    1    1.041954693
 2  900 2  900 
 
 i   8.39% 8.3909385
2
4
4*
 d  4   12
(ii) 900  925  1  
 4 
 
16
12
 d  4 12 900 d    900 16
4
 1     1    0.979660466
 4  925 4  925 
 
 d    8.14% 8.1358136
4
 4 
(iii)
 12 
 
900   1  i   925  i  8.33% 8.3
Where i is the simple rate of interest per annum.
This question was answered very well although some candidates calculated i   rather than
4
d   for part (ii).

4
Page 4
Firstly we must consider i   and 1  t 

2 D
4
R
where i   is evaluated at the net yield rate (6% p.a.) = 5.9126%

2
t  0.30 , the income tax rate
D 8 D
  7.7670 p.a.  1  t   5.4369%
R 1.03 R
We have i   1  t 
2 D
R
 there is a capital gain and the stock will be redeemed at the last possible date if the
minimum yield is received. i.e. at the end of 25 years.
Hence, let P be price per £100 nominal, then
 2
P = 1  0.3 8 a  103  103  P   0.4  v 25at 6% p.a.
25
 2
= 5.6a   61.8  0.4 P  v 25
25
i
5.6 a  61.8v 25
i  2  25
P =
1  0.4v 25
5.6  1.014782 12.7834  61.8  0.23300

=
1  0.4  0.23300
72.6452  14.3994
=
1  0.0932
= £95.99
Generally well-answered although some candidates’ arguments for choosing the latest
possible date were unclear.
Page 5
5 (i) The amounts of cash flows:
Coupon on 25/4/2013
0.03 RPI 4/2013

= 10, 000  
2 RPI10/2008
0.03 171.4
= 10000   = £172.319
2 149.2
Coupon on 25/10/2013
0.03 RPI10/ 2013

= 10000  
2 RPI10/ 2008
0.03 173.8
= 10000   = £174.732
2 149.2
173.8
Redemption on 25/10/2013 = 10000 
149.2
= £11, 648.794
(ii) Purchase Price at 25/10/2012 = PV at real rate of 3 12 % p.a. effective of future

cash flows.
= PV at 3 12 % p.a. effective of “25/10/2012

money values” of future cash flows.
Future cash flows expressed in 25/10/2012 money values
RPI10/2012
Coupon at 25/4/2013  172.319 
RPI 4/2013
169.4
 172.319   £170.308
171.4
RPI10/2012
Coupon at 25/10/2013  174.732 
RPI10/2013
169.4
= 174.732   £170.308
173.8
(same as 25/4/2013, as expected)
Page 6
169.4
Redemption at 25/10/2013 = 11648.794   £11,353.888
173.8
 RPI10/2012 169.4 
or 10000   10000   11353.888
 RPI10/2008 149.2 
Hence Price at 25/10/2012
1 170.308  11353.888
 170.308  
1.035
1
2 1.035
 £11,301.89
Many candidates had difficulty in recognising that the real yield would be based on using the
inflation-adjusted cashflows as at the time of purchase. Some candidates made no
adjustment at all whereas others incorrectly assumed that the inflation rate would be
constant throughout the holding period.
6 (i) Redington’s first condition states that the pv of the assets should equal the
pv of the liabilities.
Working in £ million:
pv of assets  7.404v 2  31.834v 25 at 7%

 7.404  0.87344  31.834  0.18425
 6.467  5.865
 12.3323
pv of liabilities  10v10  20v15 at 7%

=10  0.50835  20  0.36245
 5.0835  7.249
 12.3324
Allowing for rounding, Redington’s first condition is satisfied.
Redington’s second condition states that the DMT of the assets should equal
the DMT of the liabilities. Given denominator of DMTs of assets and
liabilities have been shown to be equal, we only need to consider the
numerators.
Numerator of DMT of assets  7.404  2  v 2  31.834  25  v 25 at 7%

 6.467  2  5.865  25
 159.569
Page 7
Numerator of DMT of liabilities  10 10  v10  20 15  v15 at 7%

 5.0835 10  7.249 15
 159.569
Allowing for rounding, Redington’s 2nd condition is satisfied.
(ii) Profit  7.404v 2  31.834v 25  10v10  20v15 at 7.5%

 6.40692  5.22011  4.85194  6.75932
 0.015772 i.e. a profit of £15,772
(iii) It can be seen that the spread of the assets is greater than the spread of the
liabilities. This will mean that Redington’s third condition for immunization
is also satisfied, and that therefore a profit will occur if there is a small change
in the rate of interest. Hence we would have anticipated a profit in (ii).
Parts (i) was answered well. Equating volatilities instead of DMTs was perfectly acceptable
in this part. Part (ii) was also generally answered well although some candidates estimated
the answer by using an estimation based on volatility rather than calculating the answer
directly as asked. Part (iii) was less well answered with some candidates ignoring this part
completely and others stating that Redington’s 3rd condition was satisfied without further
explanation.
7 Let Kt and St denote the forward price of the contract at time t , and the stock price at
time t respectively.
Let r be the risk-free rate per annum at time t  1

2
Then, K 0  S0e0.04
1r
and K 1  0.98 S0 e 2
2

The value of the contract V1 is K 1  K 0 e
2 2
  12 r

Hence V1 = K 1  K 0 e
2 2
  12 r
= S0   0.98e 2  e0.04  e 2
1r 1r
 
Page 8
And
1r
V1  0 when 0.98e 2  e0.04
2
 e0.04 
which is when r  2 ln   12.041% p.a.
 0.98 
 
One of the worst answered questions on the paper. Some candidates, who did not complete
the question, lost some of the marks that would have been available to them by not showing
clear working e.g. writing down one half of a formula without explaining what the formula
was supposed to represent.
8 (i) Let DPP be t . We want (all figures in £000s)
 2
50, 000 = 6, 000a at 9% p.a.
t
i
= 6, 000   at
i 
2
50
 at =
6 1.022015
= 8.1538268
 vt  1  8.1538268  0.09
ln 1  8.1538268  0.09 
t   15.360
ln1.091
Take DPP as 15.5 years
(ii) Profit at the end of 20 years is
50, 000  1.09   1.07   

 6, 000  s15.5  1.07  X
15.5 4.5 2 4.5
where
s
 2
=
1  i 15.5  1 at 9%
i 
15.5 2
1.0915.5  1
=
0.088061
= 31.8285476
Page 9
and to find X we work in half-years:
= 3, 000s9 at j % where 1  j   1.07

2
X
= 3, 000 
1  j  1
9
1.07   1
9/2
= 3, 000 
1.07 1/2  1
= 31, 030.35528
 Profit = -257,814.7272+258,937.5717+31,030.35528
= 32,153.20
  £32,153, 200 
Part (i) was answered well although candidates lost marks for not recognising that the DPP
could only be at the time of income receipt i.e. at the end of a half-year. Part (ii) was
answered badly with some candidates ignoring the initial profit obtained at the end of the
DPP. A common error in the calculation of the profit arising after the DPP was to calculate
the present value rather than the accumulated value.
9 (i) We can find the one-year forward rates f1,1 and f 2,1 from the spot rates
y1, y2 and y3 :
1  y2 2  1  y1  1  f1,1 
 1  0.037   1  0.036  1  f1,1 

2
 f1,1  3.800% p.a.
and
1  y3 3  1  y2 2 1  f 2,1 
 1.038   1.037  1  f 2,1 

3 2
 f 2,1  4.000 % p.a.
Page 10
(ii) (a) Price per £100 nominal
= 4  v  v 2  v3   105 v3
 3.6% 3.7% 3.8%  3.8%
= 4  2.78931  105  0.89414
= £105.0425
(b) Let yc2  two-year par yield
1  yc2  v  v 2   v 2
 3.6% 3.7%  3.7%
 yc2  3.6982 % p.a.
Questions on the term structure of interest rates have caused significant problems for
candidates in past years but this question was generally answered very well.
10 (i) Let X = initial payment
20000 =  X  50  a25  50  Ia 25
=  X  50  10.6748  50  98.4789
= 10.6748 X  533.74  4923.95
15609.80
X  £1, 462.31.
10.6748
(ii) After 3 years, capital o/s is:
1562.31a22  50  Ia 22
= 1562.3110.2007  50  87.1264
= £ 20, 293.01
(iii) The loan has actually increased from £20,000 to £20,293.01. The reason for
this is that the loan is being repaid by an increasing annuity and, in the early
years, the interest is not covered by the repayments (e.g. 1st year: Interest is
0.08 × 20000 = £1,600 but 1st instalment is £1462.31 and so interest is not
covered).
Page 11
(iv) Total of instalments paid
24  25
 25  1462.31   50  51557.66
2
 Total interest = 51557.66  20000 = £31557.66
Parts (i) and (ii) were answered well, although in part (ii) some candidates incorrectly
calculated the instalment that would be paid in the fourth year. Part (iii) was also answered
relatively better than similar explanation questions in previous years. Many candidates
failed to include the effect of the increasing payments in the calculation of the total
instalments in part (iv) despite having correctly allowed for this in earlier parts.
10
11 (i) PV   3, 000  t  dt
4
where   t  is as follows:
0t 4
 0.030.01t dt
t
  0.03t  12 x 0.01t 2 
 t   e o
e  
4t 6
t
0.20   4 0.07 dt
 e 0.20.e
0.07 t 0.28 
 t   e .e
 e0.080.07t
t6
t
0.34   6 0.09 dt
 e0.34 .e
0.09t  0.54 
 t   e .e
 e
0.20 0.09t 
 e0.08 0.07  dt 3, 000  e

0.200.09t 
6  10
 PV  3, 000 t
dt
4 6
3, 000e0.08  0.42 0.28  3, 000e0.20  0.90 0.54 

 e e  e e
0.07   0.09  
 4584.02  7172.83  $11, 756.85
Page 12
(ii) 
11.75685  3 a10  a4 
at i = 6%, RHS = 3(1.029709)[7.3601  3.4651] = 12.03215
at i = 7%, RHS = 3(1.034605)[7.0236  3.3872] = 11.28671
by interpolation
 12.03215  11.75685 
 i  0.06    0.01  0.06369 i.e. 6.4%
 12.03215  11.28671 
(actual answer is 6.36%)
One of the worst answered questions on the paper with the different formulation of a question
based on varying forces of interest causing problems for many candidates. It is also possible
to answer part (i) as a combination of continuous deferred annuities. Part (ii) was poorly
answered even by candidates who had made a good attempt to part (i).
12 (i) 
1  it  LogNormal ,  2 
12
S12   1  it 
1
 
12
 ln S12   ln 1  it   N 12, 12 2
1
E 1  it   1.08  exp   2 / 2 
Var 1  it   0.052  exp 2   2    exp     1
2
   
 1.082 exp  2  1
0.052
 e
2
 1
1.082
 2  0.002141053
  ln 1.08  2 / 2
 0.075890514
Hence S12 has LogNormal distribution with parameters 0.910686 and

0.025692636
Page 13
(ii) PV of annuity at time 12:
PV  4000 a   5000 a  v 4  5000 a  v6  6000 a4 v 2 v6

12 4 4
 4 
2  7%
2  7%
7% 7% 9% 9%
 1000 (4 1.037525  3.3872  5 1.043380 1.8080  0.76290

 5 1.055644 1.7591 0.66634
 6 1.044354  3.2397  0.84168  0.66634)
 1000  (14.057219  7.195791  6.186911  11.385358)

 38,825.28
Hence
Prob (18, 000 S12  38,825.28) = Prob ( S12  2.15696)
 ln  2.15696   0.910686 
= Prob  Z  
 0.025692636 
= Prob ( Z  0.8858)
=   0.89 
= 0.81
i.e. 81%
This question provided the greatest range of quality of answers. Many candidates scored
well on part (i) although common errors included assuming that E 1  it   0.08 and/or that
Var 1  it   0.05 . Few candidates calculated the correct value of the required present value
in part (ii) and candidates who made errors in this part lost further marks by not showing
clear working or sufficient intermediate steps (although the examiners recognise that some
candidates might have been under time pressure by the time they attempted this question).
The probability calculation was often answered well by candidates who attempted this part.
Page 14
EXAMINATION

Core Technical
booklet.
supervisor.
question paper.
CT1 S2014  Institute and Faculty of Actuaries

1 Describe how cash flows are exchanged in an interest rate swap. [2]
2 A life insurance company is issuing a single premium policy which will pay out
£200,000 in 20 years’ time. The interest rate the company will earn on the invested
fund throughout the 20 years will be 4% per annum effective with probability 0.25 or
7% per annum effective with probability 0.75. The insurance company uses the
expected annual interest rate to determine the premium.
(i) Calculate the premium. [2]
(ii) Calculate the expected profit made by the insurance company at the end of the
policy. [2]
[Total 4]
3 A 91-day treasury bill is bought for £98.83 and is redeemed at £100.
(i) Calculate the annual effective rate of interest from the bill. [3]
(ii) Calculate the annual equivalent simple rate of interest. [2]

[Total 5]
4 A fund had a value of £2.0 million on 1 January 2013. On 1 May 2013, £2.5 million
was invested. Immediately before this investment, the value of the fund was £2.1
million. At the close of business on 31 December 2013, the value of the fund was
£4.2 million.
(i) Calculate the annual effective time-weighted rate of return for 2013. [2]
(ii) Calculate the annual effective money-weighted rate of return for 2013. [3]
(iii) Comment on your answers to parts (i) and (ii). [2]

[Total 7]
5 Calculate, at a rate of interest of 5% per annum effective:
12 
(i) a [1]
5
(ii) 4| a15 [1]
(iii) ( Ia )10 [1]
(iv) ( Ia )10 [1]
CT1 S2014–2
(v) the present value of an annuity that is paid annually in advance for 10 years
with a payment of 12 in the first year, 11 in the second year and thereafter
reducing by 1 each year. [2]
[Total 6]
6 A Eurobond has been issued by a company that pays annual coupons of 5% per
annum annually in arrear and is redeemable at par in exactly 10 years’ time.
(i) Calculate the purchase price of the bond at issue at a rate of interest of 4% per
annum effective assuming that tax is paid on the coupon payments at a rate of
20%. [2]
(ii) Calculate the discounted mean term of the bond at a rate of interest of 4% per
annum effective, ignoring tax. [3]
(iii) (a) Explain why the discounted mean term of the gross payments from the
bond is lower than the discounted mean term of the net payments.
(b) State two factors other than the size of the coupon payments that would
affect the discounted mean term of the bond. [3]
(iv) Calculate the price of the bond three months after issue at a rate of interest of
4% per annum effective assuming tax is paid on the coupon payments at a rate
of 20%. [1]
[Total 9]
7 The force of interest, (t), is a function of time and at any time t, measured in years, is
0.03 for 0  t  10

(t )  0.003t for 10  t  20

0.0001t
2
for t  20
(i) Calculate the present value of a unit sum of money due at time t = 28. [7]
(ii) (a) Calculate the equivalent constant force of interest from t = 0 to t = 28.
(b) Calculate the equivalent annual effective rate of discount from

t = 0 to t = 28. [3]
A continuous payment stream is paid at the rate of e 0.04t per unit time between t = 3
and t = 7.
(iii) Calculate the present value of the payment stream. [4]

[Total 14]

8 (i) Explain what is meant by the following theories of the shape of the yield
curve:
(a) market segmentation theory

(b) liquidity preference theory [4]
Short-term, one-year annual effective interest rates are currently 6%; they are
expected to be 5% in one year’s time; 4% in two years’ time and 3% in three years’
time.
(ii) Calculate the gross redemption yields from one-year, two-year, three–year and
four-year zero coupon bonds using the above expected interest rates. [4]
The price of a coupon-paying bond is calculated by discounting individual payments

from the bond at the zero–coupon yields in part (ii).
(iii) Calculate the gross redemption yield of a bond that pays a coupon of 4% per
annum annually in arrear and is redeemed at 110% in exactly four years. [5]
(iv) Explain why the gross redemption yield of a bond that pays a coupon of 8%
per annum annually in arrear and is redeemed at par would be greater than that
calculated in part (iii). [2]
The government introduces regulations that require banks to hold more government
bonds with very short terms to redemption.
(v) Explain, with reference to market segmentation theory, the likely effect of this
regulation on the pattern of spot rates calculated in part (ii). [2]
[Total 17]
9 A government issued a number of index-linked bonds on 1 June 2012 which were

redeemed on 1 June 2014. Each bond had a nominal coupon of 2% per annum,
payable half yearly in arrear and a nominal redemption price of 100%. The actual
coupon and redemption payments were indexed according to the increase in the retail
price index between three months before the issue date and three months before the
relevant payment dates. No adjustment is made to allow for the actual date of
calculation of the price index within the month or the precise coupon payment date
within the month.
The values of the retail price index in the relevant months were:
Date Retail Price Index

March 2012 112
June 2012 113
September 2012 116
December 2012 117
March 2013 117
June 2013 118
September 2013 120
December 2013 121
March 2014 121
June 2014 122
CT1 S2014–4
An investor purchased £3.5m nominal of the bond at the issue date and held it until it
was redeemed. The investor was subject to tax on coupon payments at a rate of 25%.
(i) Calculate the incoming net cash flows the investor received. [5]
(ii) Express the cash flows in terms of 1 June 2012 prices. [4]
(iii) Calculate the purchase price of the bond per £100 nominal if the real net
redemption yield achieved by the investor was 1.5% per annum effective. [3]
When the investor purchased the security, he expected the retail price index to rise
much more slowly than it did in practice.
(iv) Explain whether the investor’s expected net real rate of return at purchase
would have been greater than 1.5% per annum effective. [2]
In September 2012, the government indicated that it might change the price index to
which payments were linked to one which tends to rise more slowly than the retail
price index.
(v) Explain the likely impact of such a change on the market price of index-linked
bonds. [2]
[Total 16]

10 A student is considering whether to attend university or enter a profession
immediately upon leaving school. If he enters the profession immediately, his salary
is expected to be as follows.
Year 1: £15,000
Year 2: £18,000
Year 3: £20,000
In each subsequent year the expected salary would rise by 1% per annum compound.
The salary is assumed to be received monthly in arrear for 40 years.
If he attends university, the fees and other costs will be £15,000 per annum for three
years, paid annually in advance. After attending university, the student’s potential
earnings will rise. Immediately after leaving university, he expects to earn £22,000 in
the first year, £25,000 in the second year and £28,000 in the third year. Thereafter,
his salary is expected to rise each year by 1.5% per annum compound. The salary
would be paid monthly in arrear for 37 years.
(i) Calculate the present value of the student’s earnings if he enters the profession
immediately at a rate of interest of 7% per annum effective. [7]
(ii) Calculate the net present value of the decision to attend university at a rate of
interest of 7% per annum effective and hence determine whether attending
university would be a more attractive option. [9]
(iii) Explain why attending university would be relatively more attractive at lower
interest rates. [2]
The student wishes to consider the effect of taxation on earnings.
(iv) Determine the rate of income tax above which the option of attending
university would be less attractive financially than that of entering the
profession immediately. [2]
[Total 20]
END OF PAPER
CT1 S2014–6
EXAMINERS’ REPORT

Core Technical
Introduction
The report is written based on the legislative and regulatory context at the date the
examination was set. Candidates should take into account the possibility that circumstances
may have changed if using these reports for revision.
F Layton
November 2014

answered well by most candidates. In general the non-numerical questions were answered
poorly by marginal candidates. This applied to bookwork questions such as Q1 and Q8(i) as
well as questions requiring interpretation of answers such as Q4(iii), Q8(iv) and (v) and
Q9(iv) and (v).
Page 2
1 One party agrees to pay to the other a regular series of fixed amounts for a certain
term. In exchange, the second party agrees to pay a series of variable amounts in the
same currency based on the level of a short term interest rate. [2]
2 (i) Expected annual interest rate
= 0.25 × 4 + 0.75 × 7 = 6.25%
Let premium = P
P (1.0625)20 = 200,000
 P = £59,490.99 [2]
(ii) Expected accumulation is:
59,490.99 (0.25 × 1.0420 + 0.75 × 1.0720)
= 205,246.55
 Expected profit = £5,246.55 [2]

[Total 4]
Many candidates struggled to distinguish between the use of an expected annual interest rate
and the expected accumulation after 20 years.
3 (i) 98.83 = 100 (1 + i)91/365
 365 
ln(1  i )      ln(98.83 / 100)  0.047205
 91 
Therefore i = 0.04834. [3]
(ii) The rate of interest over 91 days is
(100 – 98.83) / 98.83 = 0.011839
The simple rate per annum is:
365
0.011839   0.04748 [2]
91
[Total 5]
4 (i) Let i be the TWRR per annum effective, then:
2.1 4.2
1 i    0.95870
2.0 2.1  2.5
 TWRR   4.130%p.a. [2]
(ii) Let i be the MWRR per annum effective, then:

2
2.0(1  i )  2.5(1  i ) 3  4.2
Try:  8% LHS = 4.20482

 9% LHS = 4.16765
 4.20482  4.2 
Then i  0.08  0.01  
 4.20482  4.16765 
i  8.130%  8.1%p.a. (Exact answer is -8.12985%) [3]
(iii) The MWRR is affected by the timing and amount of cashflows. The fund
performs relatively worse when the size of the fund is largest and this will
have a greater effect on the MWRR which is consequently lower than the
TWRR. [2]
[Total 7]
Parts (i) and (ii) were well-answered. In part (iii), examiners were looking for specific
comments regarding this scenario and not just a statement of the bookwork.
i
a5
5 (i) i (12) = 1.022715 × 4.3295 = 4.4278 [1]
(ii) a19  a4 = 12.0853 – 3.5460 [1]
= 8.5394
a10  10v 10
(iii)

1.05 7.7217  10 0.61391

=
0.04879
= 40.3501 [1]
Page 4
a10  10v10 1.024797  7.7217  10 0.61391

(iv) =
 0.04879
= 36.3613. [1]
(v) Present value is:
13a10  ( Ia)10
= 1.05  (13  7.7217  39.3738)
= 64.0592 [2]
[Total 6]
Generally well-answered although some candidates were unable to distinguish between the
increasing annuities in parts (iii) and (iv).
6 (i) P  0.8  5 a10  100v10 @ 4% per annum.
a10  8.1109 v10  0.67556
P = 0.8 × 5×8.1109 + 100 × 0.67556 = 100
No loss of marks for general reasoning. [2]
(ii) DMT =
 tCt vt
 Ct vt
5( Ia )10  10  100v10
=
5a10  100v10
5  41.9922  10  100  0.67556

=
5  8.1109  100  0.67556
885.525
= = 8.19 years [3]
108.1108
(iii) (a) On average the gross cash flows are earlier because of the higher
coupon payments. Therefore the discounted mean term would be
lower.
(b) Term of the bond

The gross redemption yield/interest rate at which payments are
discounted.
[3]
(iv) All payments are 3 months closer. Therefore, purchase price would be
100(1.04)¼  100.9853 [1]

[Total 9]
Parts (i) and (ii) were answered well. Many candidates’ arguments in part (iii)(a) were
unclear.
10
A(0,10) = e 0
0.03 dt 10
7 (i)  e[0.03t ]0  e0.3
20
A(10, 20) = e 10
0.003t dt
 0.003t 2  20
 
=e  2  10
= e(0.60.15)  e0.45
28
0.0001t 2 dt
A(20, 28) = e 20
28
 0.0001t 3 
 
 3  20
=e  e0.731730.26666  e0.46507
Required PV
1
=  e0.30.450.46507  e1.21507
A  0,10  A 10, 20  A  20, 28 
= 0.29669 [7]
(ii) (a) 0.29669 = e28
ln 0.29669
   0.04340  4.340% per annum
28
Page 6
(b) (1  d)28 = 0.29669
1 – d = 0.95753
d = 0.04247 = 4.247% per annum [3]
t
  0.03ds
(iii) v(t )  e 0  e0.03t
ρ(t) = e 0.04t
We require:
7 0.03t 0.04t 7
3 e e dt   e0.07t dt
3
7
 e 0.07t 
=  
 0.07  3
= 8.75181 + 11.57977
= 2.82797 [4]
[Total 14]
Answered well. The common mistake was to calculate the effective rate of interest rather
than the effective rate of discount in part (ii)(b).
8 (i) (a) Bonds of different terms are attractive to different investors, who will
choose assets that are appropriate for their liabilities. The shape of the
yield curve is determined by supply and demand at different terms to
redemption.
(b) Longer dated bonds are more sensitive to interest rate movements than
short dated bonds. It is assumed that risk averse investors will require
compensation (in the form of higher yields) for the greater risk of loss
on longer bonds.
[4]
(ii) Let it be the spot yield over t years.
One year: yield is 6% therefore i1 = 0.06

Two years: (1 + i2)2 = 1.06 × 1.05 therefore i2 = 0.054988
Three years: (1 + i3)3 = 1.06 × 1.05 ×1.04 therefore i3 = 0.049968.
Four years: (1 + i4)4 = 1.06 × 1.05 × 1.04 × 1.03 therefore i4 = 0.04494.
[4]
(iii) Price of bond is:
4[(1.06)1 + (1.054988)2 + (1.049968)3 + (1.04494)4]

+ 110 × 1.044944
= 4 × 3.54454 + 92.26294
= 106.4411
Find the gross redemption yield from:
106.4411  4a4  110v 4
Try 4%
a4 =3.6299 v 4  0.85480
RHS = 108.5476
Try 5%
a4 = 3.5460 v 4  0.82270
RHS = 104.681
Interpolate between 4% and 5%:
108.5476  106.4411
i = 0.04  0.01
108.5476  104.681
= 0.0454
= 4.54%
[5]
(iv) On average, the payments would be received earlier and discounted at higher
spot rates. This means that the gross redemption yield (which is a weighted
average of the interest rates used to discount the payments) would be higher.
[2]
(v) The earlier spot rates are likely to fall as a result of greater demand for the
bonds with shorter terms to redemption. [2]
[Total 17]
Parts (i) and (iii) were generally answered well with correct approaches in part (iii) given
full credit even if the calculations in part (ii) had been incorrect. In common with other
similar questions on this paper, the reasoning questions in parts (iv) and (v) were poorly
answered.
Page 8
9 (i)
Date Nominal Cash Flow Indexed Cash Flow
£m £m
1/12/2012 0.0075×3.5 = 0.02625 (116/112)×0.02625 = 0.0271875
1/6/2013 0.0075×3.5 = 0.02625 (117/112)×0.02625 = 0.0274219
1/12/2013 0.0075×3.5 = 0.02625 (120/112)×0.02625 = 0.028125
1/6/2014 (1 + 0.0075)×3.5 = 3.52625 (121/112)×3.52625 = 3.8096094
[5]
(ii)
Date Indexed Cash Flow Index Ratio Real Value of Cash flow
£m £m
1/12/2012 0.0271875 113/117 0.0262580
1/6/2013 0.0274219 113/118 0.0262599
1/12/2013 0.028125 113/121 0.0262655
1/6/2014 3.8096094 113/122 3.5285726
[4]
(iii) Value of £3.5m nominal is:
0.0262580v½ + 0.0262599v + 0.0262655v1½ + 3.5285726v2
= 0.0262580 × 0.992583 + 0.0262599 ×0.98522 + 0.0262655 ×0.97791
+ 3.5285726 × 0.97066
= £3.502657m
3.502671
Per £100 nominal =  100
3.5
= £100.0763 [3]
(iv) The expected rate of return at issue is likely to have been higher. Although the
investor is compensated for the higher-than-expected inflation, the time lag
used for indexation is likely to mean that he is not fully compensated.
Therefore the actual real value of the cash flows is less than the expected real
value of the cash flows at issue. [2]
(v) It is likely that the price will fall. The expected real value of the cash flows
measured will be lower because the cash flows will be linked to an index
expected to rise at a lower rate. [2]
[Total 16]
The most poorly answered question on the paper. Better candidates took advantage of the
relatively large number of marks available in parts (i) and (ii) for straightforward
calculation work. The important point in part (iii) is to note that the real redemption yield
equation uses inflation adjusted cashflows (in terms of 1 June 2012 prices in this case). In
part (iv), the important point is that the time lag causes the investor not to be fully protected
against inflation. If there had been no time lag, the actual increase in the retail price index
would have no effect on the investor’s real rate of return.
10 (i) Present value of earning if university is not attended:
15, 000 a (12)  18, 000 a (12) v  20, 000 a (12) v 2  20, 000a (12)
1 1 1 1
1.01v3 (1  1.01v  ...  1.0136 v36 )
i
= (12)
a1 (15, 000  18, 000v  20, 000v 2 )
i
3   1  1.01 v 
37 37
 i
  20, 000 (12) a1 *1.01v   
 i   1  1.01v 
i
= 1.031691; a1  v  0.93458
i (12)
v2 = 0.87344; v3 = 0.81630; 1.0137 = 1.445076
v37 = 0.08181.
1.031691 × 0.93458 (15,000 + 18,000 × 0.93458 + 20,000 × 0.8734)
+ (20,000 × 1.031691 × 0.93458
 1  1.445076  0.081809 
×1.01 × 0.81630)  
 1  1.01 0.9346 
= 47,527.46 + 15,898.86 × 15.7252
= £297,537.30 [7]
(ii) The cost of going to university is:
15, 000  a3 @ 7%  42,120.27
a3  2.6243 1.07  2.8080
Page 10
The PV of the salary from attending university at the time of leaving

university is:
22, 000 a (12)  25, 000 (12) v  28, 000 a (12) v 2

1 1 1
28, 000 a (12) 1.015v3 (1  1.015v    1.01533 v33 )

1
i
= a (22, 000  25, 000v  28, 000v 2 )
(12) 1
i
  1  1.015 v 
34 34
 i
+  28, 000 (12) a1 1.015v3   
 i   1  1.015v 
1.01534 = 1.658996
v34 = 0.10022
= 1.031691 × 0.93458(22,000 + 25,000 × 0.93458
+ 28,000 × 0.87344) + 28,000 × 1.031691 × 0.93458 × 1.015
 1  1.658996  0.10022 
× 0.81630  
 1  1.015  0.93458 
= 67,321.02 + 22,368.60 × 16.21996
= 430,138.80
PV at time of decision = 430,138.80 × v3
= 430,138.80 × 0.81630 = £351,121.46
There are various ways in which the answer can be rationalised.
NPV of benefit of going to university (net of earnings lost through the

alternative course of action)
= 351,121.46 – 42,120.27 – 297,537.30
= £11,463.89 [9]
(iii) The costs of going to university are incurred earlier and the benefits received
later. If the rate of interest is lower, then any loans taken out to finance
attendance at university will be repaid more easily at a lower interest cost
(answer could say that value of payments received later will rise by more
when the interest rate falls). [2]
(iv) Tax is paid on income only at rate t.
Therefore, equation of value is:
351,121.46 (1 – t) = 42,120.27 + 297,537.30 × (1  t)
351,121.46 – 42,120.27 – 297,537.30
= t (351,121.46 – 297,537.30)
 11,463.89 = 53,584.16t
 t = 0.2139 or 21.39% [2]

[Total 20]
Parts (i) and (ii) were often well-answered although marginal candidates would have
benefited from setting out their working more clearly and some candidates failed to’
determine whether attending university would be a more attractive option’ despite having
completed the requisite calculations.
Part (iii) was poorly answered by marginal candidates with few such candidates correctly
considering the relative timing of the costs and benefits. Few such candidates attempted part
(iv) perhaps because of time pressure. Stronger candidates, however, often obtained close to
full marks on the question.
Page 12
EXAMINATION
20 April 2015 (pm)

Core Technical
booklet.
supervisor.
question paper.
CT1 A2015  Institute and Faculty of Actuaries

1 Explain why the running yield from property investments tends to be greater than that
from equity investments. [3]
2 Calculate the time in days for £3,000 to accumulate to £3,800 at:
(a) a simple rate of interest of 4% per annum.

(b) a compound rate of interest of 4% per annum effective.
[4]
3 A 182-day treasury bill, redeemable at $100, was purchased for $96.50 at the time of
issue and later sold to another investor for $98 who held the bill to maturity. The rate
of return received by the initial purchaser was 4% per annum effective.
(i) Calculate the length of time in days for which the initial purchaser held the
bill. [2]
(ii) Calculate the annual simple rate of return achieved by the second investor. [2]
(iii) Calculate the annual effective rate of return achieved by the second investor.
[2]
[Total 6]
4 (i) Describe what is meant by the “no arbitrage” assumption in financial

mathematics. [2]
A 9-month forward contract is issued on 1 April 2015 on a stock with a price of £6

per share on that date. Dividends are assumed to be received continuously and the
dividend yield is 3.5% per annum.
(ii) Calculate the theoretical forward price per share of the contract, assuming no
arbitrage and a risk-free force of interest of 9% per annum. [2]
The actual forward price per share of the contract is £6.30 and the risk-free force of
interest is as in part (ii).
(iii) Outline how an investor could make an arbitrage profit. [2]

[Total 6]
5 An investor pays £120 per annum into a savings account for 12 years. In the first four
years, the payments are made annually in advance. In the second four years, the
payments are made quarterly in advance. In the final four years, the payments are
made monthly in advance.
The investor achieves a yield of 6% per annum convertible half-yearly on the

investment.
Calculate the accumulated amount in the savings account at the end of 12 years. [7]
CT1 A2015–2
6 An ordinary share pays annual dividends. The next dividend is expected to be 6p per
share and is due in exactly six months’ time. It is expected that subsequent dividends
will grow at a rate of 6% per annum compound and that inflation will be 4% per
annum. The price of the share is 175p and dividends are expected to continue in
perpetuity.
Calculate the expected effective real rate of return per annum for an investor who
purchases the share. [6]
7 In a particular country, insurance companies are required by regulation to value their

liabilities using spot rates of interest derived from the government bond yield curve.
Over time t (measured in years), the spot rate of interest is equal to:
i  0.02t for t  5
An insurance company in this country has a group of annuity policies which involve
making payments of £1m per annum for four years and £2m per annum in the fifth
year. All payments are assumed to be paid halfway through the year.
(i) Calculate the value of the insurance company’s liabilities. [3]
(ii) Outline two reasons why the spot yield curve might rise with term to
redemption. [3]
(iii) Calculate the forward rate of interest from time t = 3.5 to time t = 4.5. [2]
[Total 8]
8 A fixed-interest security, redeemable at par in 10 years, pays annual coupons of 9% in

arrear and has just been issued at a price to give an investor who does not pay tax a
rate of return of 7% per annum effective.
(i) Calculate the price of the security at issue. [2]
(ii) Calculate the discounted mean term (duration) of the security at issue. [3]
(iii) Explain how your answer to part (ii) would differ if the annual coupons on the
security were 3% instead of 9%. [2]
(iv) (a) Calculate the effective duration (volatility) of the security at the time of
issue.
(b) Explain the usefulness of effective duration for an investor who

expects to sell the security over the next few months. [3]
[Total 10]

9 A property development company has just purchased a retail outlet for $4,000,000. A
further $900,000 will be spent refurbishing the outlet in six months’ time.
An agreement has been made with a prospective tenant who will occupy the outlet
beginning one year after the purchase date. The tenant will pay rent to the owner for
five years and will then immediately purchase the outlet from the property
development company for $6,800,000. The initial rent will be $360,000 per annum
and this will be increased by the same percentage compound rate at the beginning of
each successive year. The rental income is received quarterly in advance.
Calculate the compound percentage increase in the annual rent required to earn the
company an internal rate of return of 12% per annum effective. [9]
10 The force of interest, δ(t), is a function of time and at any time t (measured in years) is
given by
0.08 for 0  t  4

(t )  0.12  0.01t for 4  t  9
0.05 for t  9

(i) Determine the discount factor, v(t), that applies at time t for all t ≥ 0. [5]
(ii) Calculate the present value at t = 0 of a payment stream, paid continuously

from t = 10 to t = 12, under which the rate of payment at time t is 100e0.03t . [4]
(iii) Calculate the present value of an annuity of £1,000 paid at the end of each
year for the first three years. [3]
[Total 12]
CT1 A2015–4
11 On 1 January 2016, a student plans to take out a five-year bank loan for £30,000 that
will be repayable by instalments at the end of each month. Under this repayment
schedule, the instalment at the end of January 2016 will be X, the instalment at the end
of February 2016 will be 2X and so on, until the final instalment at the end of
December 2020 will be 60X. The bank charges a rate of interest of 15% per annum
convertible monthly.
an  nv n
(i) Prove that ( Ia ) n  . [3]
i
(ii) Show that X = £26.62. [4]
The student is concerned that she will not be able to afford the later repayments and
so she suggests a revised repayment schedule. The student would borrow £30,000 on
1 January 2016 as before. She would now repay the loan by 60 level monthly
instalments of 36X = £958.32 but the first repayment would not be made until the end
of January 2019 and hence the final instalment is paid at the end of December 2023.
(iii) Calculate the APR on the revised loan schedule and hence determine whether
you believe the bank should accept the student’s suggestion. [5]
(iv) Explain the difference in the total repayments made under the two
arrangements. [2]
[Total 14]
12 In any year, the yield on investments with an insurance company has mean j and
standard deviation s and is independent of the yields in all previous years.
(i) Derive formulae for the mean and variance of the accumulated value after n
years of a single investment of 1 at time 0 with the insurance company. [5]
Each year the value of (1  it ), where it is the rate of interest earned in the t th year, is
lognormally distributed. The rate of interest has a mean value of 0.04 and standard
deviation of 0.12 in all years.
(ii) (a) Calculate the parameters µ and  2 for the lognormal distribution of
(1  it ).
(b) Calculate the probability that an investor receives a rate of return

between 6% and 8% in any year.
[8]
(iii) Explain whether your answer to part (ii) (b) looks reasonable. [2]
[Total 15]
END OF PAPER
CT1 A2015–5
EXAMINERS’ REPORT

Core Technical
Introduction
The report is written based on the legislative and regulatory context at the date the
examination was set. Candidates should take into account the possibility that circumstances
may have changed if using these reports for revision.
F Layton
June 2015

answered well by most candidates. In general, the non-numerical questions were answered
poorly by marginal candidates.
Page 2
1 Dividends usually increase annually whereas rents are reviewed less often.
Property is less marketable.
Expenses associated with property investment are higher.
Large, indivisible units of property are less flexible.
On average, dividends will tend to rise more rapidly than rents because dividends
benefit from retention and reinvestment of profits in earlier years.
The worst answered question on the paper with over one-third of candidates scoring no
marks.
2 (a) Let the answer be t days
 t 
3,000  1  0.04   =3,800
 365 
t = 2,433.33 days
(b) Let the answer be t days:
t
3,000 (1.04) 365 = 3,800
t
3,800
 (1.04) 365 =
3, 000
t  3,800 
ln1.04 = ln  
365  3, 000 
t = 2,199.91 days.
3 (i) 96.5(1.04)t = 98
t × ln(1.04) = ln(98/96.5)
Therefore, t = 0.3933 years = 143.54 days (144 days)
(ii) The second investor held the bill for 182–144 = 38 days
 38 
Therefore 98  1  i  = 100
 365 
 100  365
i=   1  = 0.19603 or 19.603%
 98  38
Page 3
(iii) The actual rate of interest over 38 days was (100/98) – 1 = 0.020408
Annual effective rate over 1 year would be:
(1 + 0.020408)365/38  1 = 0.21416 or 21.416%
4 (i) The “no arbitrage” assumption means that neither of the following applies:
(a) an investor can make a deal that would give her or him an immediate
profit, with no risk of future loss;
(b) an investor can make a deal that has zero initial cost, no risk of future
loss, and a non-zero probability of a future profit.
 0.090.035129
(ii) The theoretical price per share of the forward contract is £6e
 £6.2527
(iii) In this case the actual forward price is too expensive in relation to the stock.
0.035 9 0.035 9
The investor should borrow £6e 12 and use this to buy e 12 units of
the stock. The investor will also go short in one forward contract. The
continuous dividends are reinvested in the stock. (Mark given for general
strategy, exact amounts not required).
0.035 9
12  e
0.035 9
[After nine months, the investor will have e 12 =1 unit of stock
that can be sold under the terms of the forward contract for £6.30. The
9 0.09 9
0.03512
investor will also have to repay cash of £6e e 12  £6.2527 .]
Whilst it was not required for candidates to give a full mathematical explanation for part
(iii), they were expected to recognise that the forward was overpriced and to determine the
arbitrage strategy accordingly.
Page 4
5 We will use the ½-year as the time unit because the interest rate is convertible half
yearly. The effective rate of interest is 3% per half year.
120
s8  1.03  60s 2   1.03  60s 6  at 3%
16 8
Accumulated amount =
a2 8 8
6
 6  d  6  1 1
We need d from 1    1  d  
 6  1  i 1.03
d  6  1  6   1  
1 1
6
6
 1    d = 1    6

6  1.03    1.03  
= 0 .029486111
Thus accumulated amount =
120 i i
s8  1.03  60 s8  1.03  60
16 8
s at 3%
d  d 
a2 2 6 8
120 0.03
  8.8923 1.60471  60  1.022445  8.8923 1.26677  60   8.8923
1.9135 0.029486111
= 894.877 + 691.040 + 542.837
= £2,128.75
(above uses factors in formulae and tables book; if book not used then exact answer is
£2,128.77).
Generally well-answered but marginal candidates would have benefited from showing their
intermediate working in greater depth and/or with greater clarity.
Page 5
6 Let:
i  nominal yield
e  inflation rate
i  real rate
Then
1  i  1  i 1  e 
We first find i and then use above equation to find i :
6  1.06 
2
6 6 1.06
175 = 1
 1
 1

1  i  2
1  i 1 2 1  i 2 2
6  1.06 1.06 2 
 1     
1  i 
1
2  1  i 1  i 2 
 
 
6  1 
 1  1.06 
1  i  2
 1 
 1 i 
1
6 1  i  2

1  i  1 
1.06 

 1 i 
1
6 1  i  2

i  0.06
Let i  10%, RHS = 157.32

i  9% , RHS = 208.81
Hence
 208.81  175 
i  0.09  0.01   
 208.81  157.32 
= 0.09657 (answer to nearest 0.1% is 9.6%)
Page 6
Then we have
1.09657  1  i 1.04
 i  5.44% p.a. real return (answer to nearest 0.1% is 5.4%)
An alternative method of formulating the equation in real terms to find i’ directly was
perfectly valid.
7 (i) Time Spot rate of interest
½ 0.01
1½ 0.03
2½ 0.05
3½ 0.07
4½ 0.09
Value of liabilities (£m)
 0.5
V  1 v1% 1.5
 v3% 2.5
 v5%  v7%
3.5 4.5
 2v9%
½ = 0.99504
1%v
1.5 = 0.95663
3%v
2.5 = 0.88517
5%v
3.5 = 0.78914
7%v
4.5 = 0.67855
9%v
V = 4.98308
(ii) Because expectations of short-term interest rates rise with term and the yield
curve is determined by expectations theory.
Because investors have a preference for liquidity which puts an upwards bias
on the yield curve (e.g. because long-term bonds are more volatile). A rising
curve would be compatible, for example, with constant expectations of interest
rates.
Because the market segmentation theory holds and investors short-term bonds
might be in demand by investors such as banks (or there is an undersupply of
short-term bonds or less demand/more supply for long-term bonds).
(iii) Spot rate to time 4.5 is 9%. Spot rate to time 3.5 is 7%. Therefore:
1.094.5/(1.07)3.5 = forward rate from 3.5 to 4.5 = 16.3%
Common errors in part (i) were to assume payments at the end of the year and/or to assume
that the payments should be valued with the end of year spot rate (2%, 4%, 6% etc.)
Page 7
8 (i) P  9a10 7%  100v10

7%
v10  0.50835; a10  7.02358
P = 9  7.02358  100  0.50835
 114.047
(ii) Discounted mean term
 tCt vt

 Ct vt
9  Ia 10  10 100v10

114.047
9  34.7391  10 100  0.50835


114.047
= 7.199 years
(iii) Duration will be higher because the payments will be more weighted towards
the end of the term.
(iv) (a) Effective duration = duration / 1  i 
 7.199 /1.07  6.728 years
(b) Effective duration would indicate the extent to which the value of the
bond would change if there were a uniform change in interest rates. It
is therefore an indication of the risk to which the investor is exposed if
interest rates rise and the price of the security falls before it is sold.
Many of the explanations from candidates in part (iii) were very unclear.
Page 8
9 Present value of outgoings = 4,000,000 + 900,000v½
@12%  4,850, 420
Present value of income =
 4  4
360, 000va  360, 000 1  k  v 2 a
1 1
4  4
   360, 000v5 1  k  a  6,800, 000 v 6
1
 4
 
 360, 000 a v 1  v j  v 2j  v3j  v 4j  6,800, 000 v 6
1
1.12
where j  1
1 k
 4
a  0.95887@12%
1
1
So, present value of income  360, 000  0.95887   a j  6,800, 000 v 6
1.12 5
 308, 209a j  3, 445, 092

5
Hence, for IRR = 12%, 4,850,420 = 308, 209 a j  3, 445, 092
5
so a j  4.55966
5
At 4% a5  4.62990
5% a5  4.54595
4.62990  4.55966
j  4  4.837%
4.62990  4.54595
1.12
j 1
1 k
1.12
0.04837  1
1 k
1.04837 1  k   1.12
1.12
k  1  0.0683  6.83% (exact answer is 6.84%)
1.04837
Page 9
Marginal candidates again would have benefited from showing more intermediate working.
In project appraisal questions, it is good exam technique to show working and answers for
each component of income and outgo separately so that partial marks can be given if any
errors are made within a component.
10 (i) For 0  t  4 :
v  t  = exp      s  ds   exp    0.08ds 

t t
 0   0 
 e 0.08t and v  4   e 0.084  e0.32
For 4  t  9 :
v  t  = exp      s  ds     s  ds   e0.32 exp    0.12  0.01sds 

4 t t
 0 4   4 
t
= e 0.32 exp  0.12 s  0.005s 2 
 4

 e0.32 exp 0.48  0.08  0.12t  0.005t 2 
2
= e0.080.12t 0.005t
and v  9   e0.080.1290.00581  e 0.595
For t  9 :
v  t  = exp      s  ds     s  ds   e0.595 exp    0.05ds 

9 t t
 0 9   9 
= e 0.595 exp  0.05s 9  e0.595 exp  0.45  0.05t   e 0.1450.05t

t
Page 10
(ii) Present value is
12 0.03t    t  s ds   dt
10 100 e  exp  0    
  
12
  100e0.03t e 0.1450.05t dt
10
12
12 0.1450.02t 100e 0.1450.02t 
  100e dt   
10  0.02 10
 
12
  5, 000e 0.1450.02t   5, 000 e 0.345  e0.385
 10
 138.85
1  e0.083
(iii) Present value = 1, 000a3 8%  1, 000  £2,561.89
e0.08  1
11 (i)  Ia n  v  2v 2  3v3    nv n (1)
1  i  Ia n  1  2v  3v 2    nv n1 (2)
 2   1  i  Ia n  1  v  v 2    v n1  nv n
  Ia n 
1  v  v 2

   v n 1  nv n

an  nv n
i i
(ii) Work in months i.e. use a monthly interest rate of 1.25% per month effective:
 a  60v 60 
2
30, 000  Xv  2 Xv    60 Xv 60
 X  Ia 60 @1.25%  X  60 
 i 
 
 1  v 60  1  1.012560 60 
60    60  1.0125 
  60v 
 0.0125 1.0125 
X  d  X
 i   0.0125 
   
   
 1126.8774X  X  £26.62
Page 11
(iii) Equation of value:
30, 000  v36 958.32a60
 v36 a60  31.3048
Try i = 1%: LHS = 31.4202
Try i = 1.1%: LHS = 29.5098
 31.3048  31.4202 
Interpolate: i  1%  0.1%    1.0060%
 29.5098  31.4202 
APR is 1  0.010060   1  12.8% to 1 d.p.

12
The bank is unlikely to be happy to accept the suggestion as it will be earning

a lower rate of return compared with the original proposal of 15% per annum
convertible monthly (=16.1% per annum effective).
(iv) The student’s arrangement will lead to a greater total of payments

(60 payments of 36X) when compared to the original arrangement
(60 payments of 30.5X on average) but will incur a lower rate of interest. This
is because under the student’s arrangement no capital or interest will be paid
for three years. The extra total of payments will not be sufficient to cover the
deferred interest at the bank’s preferred rate.
In part (i), candidates were expected to show the first and last terms of each series used to
derive the result so that the proof is absolutely clear. In part (ii), candidates should show
enough steps to demonstrate that they have performed the calculations required to actually
prove the answer (e.g. show the numerical values for the factors used) . In part (iv), if
interpolating on a monthly interest rate (as in the above solution) the guesses most be close
enough together to ensure the estimated annual rate is close enough to the correct answer.
12 (i) Let S n  Accumulated value at time n of £1 invested at time 0
Sn = 1  i1 1  i2  .... 1  in 
 E  Sn  = E 1  i1 1  i2  .... 1  in  
 E 1  i1  . E 1  i2  .... .E 1  in  by independence
and E 1  it   1  E  it   1  j
Page 12
Hence
E  Sn   1  j 
n
Now
Var  Sn  = E  Sn2    E  Sn 
2
 
= E 1  i1  1  i2  .... 1  in  
2 2 2
E  Sn2 
   
= E 1  i1   . E 1  i2   .... .E 1  in  

2 2 2
     
by independence
and
   
E 1  it   = E  1  2it  it2 
2
 
= 1  2 E  it   E it2  
and
 
Var it   s 2 = E it2   E  it  
2
 
= E it2  j 2
 
 E it2  s 2  j 2
Hence
 
n
E  Sn2   1  2 j  j 2  s 2
 
and
 
n
Var  Sn   1  2 j  j 2  s 2  1  j 
2n
Page 13
(ii) (a) E 1  it   1  E  it   1  j  1.04  e

 
2
2
Var 1  it   Var  it   s 2  0.122  e

 22  
e 1
2
0.122 2
  e  1
1.04  2
2
  0.12 2 
   Ln 1    
  1.04  
 2  0.013226
 0.013226 
  
1.04  e 2 
0.013226
  = Ln 1.04 
2
= 0.032608
(b) Ln 1  it   N  0.032608, 0.013226 
and we require probability 0.06  it  0.08
 Pr 1.06  1  it  1.08
 Pr  Ln 1.06  Ln 1  it   Ln 1.08 
 Ln 1.06  0.032608 Ln 1  it    Ln 1.08  0.032608 

 Pr    
 0.013226  0.013226 
 Pr  0.22    0.39  where   N  0,1
=   0.39     0.22 
 0.65173  0.58706  0.0647
i.e. 6% probability (using exact Φ function gives probability of 6.2%)
(iii) The probability in (ii) (b) is small. This is reasonable since the expected
return in any year is 4%, and we are being asked to calculate the probability
that the return is between 6%, and 8% (i.e. a range which does not include the
expected value).
Page 14
In part (i), it is important to note when the assumption of independence is required for both
proofs. Common mistakes in the calculation of ߤ and ߪ were to assume that s2 was 0.12
(rather than s) and 1 + j was 0.04 (rather than 1.04).
Page 15
1
2 INSTITUTE AND FACULTY OF ACTUARIES
3
4
5
6
7
EXAMINATION
8
9 30 September 2015 (pm)
10
11 Subject CT1 – Financial Mathematics
12 Core Technical
13
14
15
16
17 1. Enter all the candidate and examination details as requested on the front of your answer
booklet.
18
19
supervisor.
20
21
22 4. Attempt all nine questions, beginning your answer to each question on a new page.
23 5. Candidates should show calculations where this is appropriate.

24
25 Graph paper is NOT required for this paper.
26
27
28 Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
29
30 In addition to this paper you should have available the 2002 edition of the Formulae
31
32
33
34
35 CT1 S2015  Institute and Faculty of Actuaries
1 An investor wishes to obtain a rate of interest of 3% per annum effective from a
91-day treasury bill.
Calculate:
(a) the price that the investor must pay per £100 nominal.
(b) the annual simple rate of discount from the treasury bill.
[3]
2 The nominal rate of discount per annum convertible monthly is 5.5%.
(i) Calculate, giving all your answers as a percentage to three decimal places:
(a) the equivalent force of interest.
(b) the equivalent effective rate of interest per annum.
(c) the equivalent nominal rate of interest per annum convertible monthly.
[3]
(ii) Explain why the nominal rate of interest per annum convertible monthly
calculated in part (i)(c) is less than the equivalent annual effective rate of
interest calculated in part (i)(b) [1]
(iii) Calculate, as a percentage to three decimal places, the effective annual rate of
discount offered by an investment that pays £159 in eight years’ time in return
for £100 invested now. [1]
(iv) Calculate, as a percentage to three decimal places, the effective annual rate of
interest from an investment that pays 12% interest at the end of each two-year
period. [1]
[Total 6]
3 An insurance company has sold a pension product to an individual. Under the

arrangement, the individual is to receive an immediate annuity of £500 per year
annually in arrear for 12 years. The insurance company has invested the premium it
has received in a fixed-interest bond that pays coupons annually in arrear at the rate of
5% per annum and which is redeemable at par in exactly eight years.
(i) Calculate the duration of the annuity at an interest rate of 4% per annum
effective. [2]
(ii) Calculate the duration of the bond at an interest rate of 4% per annum
effective. [3]
(iii) State with reasons whether the insurance company will make a profit or a loss
if there is a small increase in interest rates at all terms. [2]
[Total 7]
CT1 S2015–2
4 A nine-month forward contract was issued on 1 October 2015 on a share with a price
at that date of £10. Dividends of 50 pence per share are expected on 1 November
2015 and 1 May 2016. The risk-free force of interest is 5% per annum.
(i) Calculate the forward price at issue, stating any further assumptions made and
showing all workings. [4]
(ii) Explain why the expected price of the share nine months after issue does not
have to be taken into account when pricing the forward. [2]
[Total 6]
5 An individual can obtain a force of interest per annum at time t, measured in years, as
0.03  0.005t 0  t  3
(t )  
0.005 t 3
(i) Determine the amount the individual would need to invest at time t = 0 in
order to receive a continuous payment stream of £5,000 per annum from time
t = 3 to time t = 6. [5]
(ii) Determine the equivalent constant annual effective rate of interest earned by
the individual in part (i). [3]
(iii) Determine the amount an individual would accumulate from the investment of
£300 from time t = 0 to time t = 50. [2]
[Total 10]
6 Three bonds, each paying annual coupons in arrear of 3% and redeemable at £100 per
£100 nominal, reach their redemption dates in exactly one, two and three years’ time,
respectively.
The price of each bond is £101 per £100 nominal.
(i) Determine the gross redemption yield of the three-year bond. [3]
(ii) Calculate the one-year, two-year and three-year spot rates of interest implied
by the information given. [5]
(iii) Calculate the one-year forward rate starting from the end of the second year,
f 2,1 . [2]
The pattern of spot rates is upward sloping throughout the yield curve.
(iv) Explain, with reference to the various theories of the yield curve, why the yield
curve might be upward sloping. [4]
[Total 14]

7 A special type of loan is to be issued by a company. The loan is made up of 100,000
bonds, each of nominal value €100. Coupons will be paid semi-annually in arrear at a
rate of 4% per annum. The bonds are to be issued on 1 October 2015 at a price of
€100 per €100 nominal. Income tax will be paid by the bond holders at a rate of 25%
on all coupon payments.
Exactly half the bonds will be redeemed after ten years at €100 per €100 nominal.
The bonds that are redeemed will be determined by lot (i.e. the bonds will be
numbered and half the numbered bonds will be chosen randomly for redemption).
Coupon payments on the remaining bonds will be increased to 7% per annum and
these bonds will be redeemed 20 years after issue at €130 per €100 nominal.
An individual buys a single bond.
Calculate, as an effective rate of return per annum:
(i) the maximum rate of return the individual can obtain from the bond. [5]
(ii) the minimum rate of return the individual can obtain from the bond. [2]
(iii) the expected rate of return the individual will obtain from the bond [2]
An investor is considering buying the whole loan.
(iv) Show that the rate of return that the investor will obtain is greater than the
expected rate of return that the above individual who buys a single bond will
receive. [5]
[Total 14]
CT1 S2015–4
8 (i) State the characteristics of an equity. [4]
An investor was considering investing in the shares of a particular company on

1 August 2014. The investor assumed that the next dividend would be payable in
exactly one year and would be equal to 6 pence per share.
Thereafter, dividends will grow at a constant rate of 1% per annum and are assumed
to be paid in perpetuity. All dividends will be taxed at a rate of 20%. The investor
requires a net rate of return from the shares of 6% per annum effective.
(ii) Derive and simplify as far as possible a general formula which will allow you
to determine the value of a share for different values of:
 the next expected dividend.

 the dividend growth rate.
 the required rate of return.
 the tax rate.
(iii) Calculate the value of one share to the investor. [5]
The company announces some news that makes the shares more risky.
(iv) Explain what would happen to the value of the share, using the formula
derived in part (ii). [2]
The investor bought 1,000 shares on 1 August 2014 for the price calculated in
part (iii). He received the dividend of 6 pence on 1 August 2015 and paid the tax due
on the dividend. The investor then sold the share immediately for 120 pence. Capital
gains tax was charged on all gains of at a rate of 25%. On 1 August 2014, the index
of retail prices was 123. On 1 August 2015, the index of retail prices was 126.
(v) Determine the net real return earned by the investor. [3]
[Total 14]

9 A student has inherited £1m and is considering investing the money in two projects, A
and B.
Project A requires the investment of the whole sum in properties that are to be let out
to tenants. The details are:
 The student expects to receive an income from rents at an annual rate of £60,000 a
year for four years after an initial period of one year in which no income will be
received.
 Rents are expected to rise thereafter at the start of each year at a rate of 0.5% per
annum.
 The income will be received monthly in advance.
 The project involves costs of £10,000 per annum in the first year, rising at a
constant rate of 0.5% per annum.
 The costs will be incurred at the beginning of each year.
 At the end of 20 years, the student expects to be able to sell the properties for £2m
after which there will be no further revenue or costs.
Project B involves the investment of the whole sum in an investment fund.
 The fund is expected to pay an income of £60,000 per annum annually in advance
and return the whole invested sum at the end of 20 years.
.
(i) (a) Calculate the payback period for project B.
(b) Show, by general reasoning or otherwise, that the payback period from
project A is longer than that from project B. [5]
(ii) (a) Define the discounted payback period.
(b) Determine the discounted payback period from project B at a rate of

interest of 1% per annum effective.
(c) Show, by general reasoning or otherwise, that the discounted payback

period from project A is longer than that from project B. [5]
(iii) Determine the internal rate of return from project B expressed as an annual
effective return. [3]
(iv) Show that the internal rate of return from project A is higher than that from
project B. [10]
(v) Discuss which project is the better project given your answers to parts (i)–(iv)
above. [3]
[Total 26]
END OF PAPER
CT1 S2015–6
EXAMINERS’ REPORT
September 2015

Core Technical
Introduction
The Examiners’ Report is written by the Principal Examiner with the aim of helping candidates, both
those who are sitting the examination for the first time and using past papers as a revision aid and
also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The Examiners have
access to the Core Reading, which is designed to interpret the syllabus, and will generally base
questions around it but are not required to examine the content of Core Reading specifically or
exclusively.
For numerical questions the Examiners’ preferred approach to the solution is reproduced in this
report; other valid approaches are given appropriate credit. For essay-style questions, particularly the
open-ended questions in the later subjects, the report may contain more points than the Examiners
will expect from a solution that scores full marks.
The report is written based on the legislative and regulatory context pertaining to the date that the
examination was set. Candidates should take into account the possibility that circumstances may
have changed if using these reports for revision.
F Layton
December 2015

A. General comments on the aims of this subject and how it is marked
1. CT1 provides a grounding in financial mathematics and its simple applications. It

introduces compound interest, the time value of money and discounted cashflow
techniques which are fundamental building blocks for most actuarial work.
2. Please note that different answers may be obtained to those shown in these solutions
calculations but candidates are not penalised for this. However, candidates may be
penalised where excessive rounding has been used or where insufficient working is
shown.
B. General comments on student performance in this diet of the

examination
1. The comments that follow the questions concentrate on areas where candidates could
have improved their performance. Where no comment is made the question was
generally answered well by most candidates.
2. Student performance was poorer than in previous years. The performance across all
questions was of a lower standard which indicated that the lower performance was not as
the result of some particularly difficult individual questions.
3. There were some ambiguities in the wording and mark scheme for Q8 but the marking
process was adjusted to ensure that candidates were not disadvantaged.
4. There were also elements of non-numerical explanation and analysis required in several
questions and, as in previous papers, students performed relatively badly on these
sections.
5. Finally, it appeared that many students left themselves short of time for the last question,
Q9, which was worth 26 marks.
C. Comparative pass rates for the past 3 years for this diet of examination
Year %
September 2015 44
April 2015 55
September 2014 57
April 2014 60
September 2013 57
April 2013 60
Page 2
Reasons for any significant change in pass rates in current diet to those in the
past:
Historically, the papers have been set by experienced examiners and this has led to very
stable pass marks and relatively stable pass rates. This paper was set by the same
examining team.
As highlighted in Section B, the performance by candidates on this paper has been

significantly poorer than for past exams in this subject. The examiners do not believe that the
paper was significantly different this session and any potential ambiguities in the paper were
fully allowed for within the marking process.
We have no definite cause for the lower marks. An analysis on a question by question basis
shows that candidates on average were only scoring above 60% on average on two
questions out of nine, one of which was the 3-mark Q1. This all suggests a relatively weak
cohort.
Solutions
Q1 P = 100(1.03)91/365 = 0.99266 or £99.266
Let annual simple rate of discount = d
99.266 91
 1 d
100 365
91
Therefore d = 0.00734; d = 0.02945
365
 12   12   0.055 12 

  ln(1  i )  ln  1     ln  1 
d
Q2 (i) (a)
    0.055126
12   
  12  
  
= 5.513%
12
 d 12   0.055 
12
(b) 1  i   1    i  1    1  0.056674 = 5.667%

 12   12 
1
i   d     0.055  1 
12 12
12 
(c) 1  1    i  12  1    1  0.055253
12  12   12  
= 5.525%
Page 3
(ii) When interest is paid monthly, the interest that is paid in earlier months itself
earns interest. This means that to achieve the same effective rate over the year,
the nominal rate must be lower.
1
 100 
8
(iii) 100  159(1  d )  d  1  

8
  0.056319 = 5.632%
 159 
1  i  1.12 2  i  0.058301  5.830%

1
(iv)
Parts (i) and (iii) were generally calculated well although many candidates
chose not to give their final answer to the requested accuracy. Some
candidates attempted to use their answers to parts (i)((a) and (i)(b) to find an
answer to part (i)(c) – this was not accepted by the examiners . Part (iv)
proved more challenging to many candidates. Amongst the marginal
candidates, there were very few who gave a clear explanation for part (ii). It
is a matter of concern that so many candidates were unable to articulate the
relationship between nominal and effective interest rates.
( Ia )12 56.6328
Q3 (i) Duration of the annuity payment is =  6.0343 years
a12 9.3851
(ii) Duration of bond is:
5( Ia )8  800v8
5a8  100v8
5  28.9133  800  0.73069

=
5  6.7327  100  0.73069
729.119
  6.8313 years
106.733
(iii) The duration of the assets (the bond) is greater than the duration of the
liabilities (pension payments). If there is a rise in interest rates, the present
value of the assets will fall by more than the present value of the liabilities and
the insurance company will make a loss.
Parts (i) and (ii) were answered well. Where a term is calculated, it is
particularly important to include the units in the final answer. Part (iii) was
very poorly answered with many candidates stating that the company must
make a loss because the durations were not equal.
Page 4
Q4 (i) Assuming no arbitrage
The present value of the dividends (in £), I, is:
I = 0.5(e0.05× (1/12) + e0.05× (7/12) ) = 0.5 × (0.995842 + 0.971255) = 0.98355
Hence, forward price F = (10 – 0.98355)e0.05(9/12) = £9.3610
(ii) The expected price of the share does not have to be taken into account
because, using the no-arbitrage assumption, the purchaser of the forward is
simply able to use the current price of the share (and the value of the
dividends) given that the forward is simply an alternative way of exposing the
investor to the same set of cash flows.
[The expected future price of the share will be taken into account by investors
when determining the price they wish to pay for the share and therefore the
current share price.]
Part (i) was often answered well although some candidates miscalculated the
timing of the dividends and the statement of the arbitrage assumption was
often missed. Part (ii) was poorly answered despite being similar to previous
exam questions.
Q5 (i) Present value is
6 6
 (t )v(t )dt   5000v(t )dt

3 3
For t  3
v(t )  exp      t  dt   exp    0.03  0.005t dt   0.005 dt 

t 3 t
 0   0 3 
3
 exp  0.03t  0.0025t 2  exp  0.005t  3
t
 0
 exp  0.1125 exp  0.015  0.005t 
 exp(0.005t  0.0975)
Page 5
Hence present value is
 5, 000 exp(0.005t  0.0975)dt

3
6
0.0975 0.005t
 5, 000e e dt
3
5, 000e0.0975  0.005t  6
 e  1, 000, 000e0.0975 (e 0.03  e0.015 )
0.005   3
 880.293.42  893,597.35  £13,303.93
(ii) 5, 000(a6  a3 )  13,303.93
i = 2%: LHS = 13,723

i = 3%: LHS = 13,136
Interpolating
13,304  13, 723

i  0.02  0.01  2.714% say 2.7%
13,136  13, 723
(iii) Accumulation =
 300 A(50)  300exp(0.005  50  0.0975)
 300e0.3475  £424.66
The discount factor was usually calculated correctly although some

candidates just calculated this factor for t = 6 and assumed that the value of a
single payment at this time was required. Part (ii) was poorly answered. The
important point is that the rate of interest is obtained by equating the amount
initially invested as calculated in part (i) with the present value of the annuity.
Q6 (i) 101  3a3  100v3
i = 3%: RHS = 100

i = 2.5%: RHS = 101.428
Interpolating
101  101.428
i  0.025  0.005   2.65%
100  101.428
Page 6
One year bond gives
101  103vi1
101
vi1   0.98058
103
103
 i1   1  1.980%
101
Two year bond gives
101  3vi1  103vi22
101
101  3
 vi22  103  0.95202
103
 i2  2.489%
Three year bond gives
101  3vi1  3vi22  103vi33
101  3  0.98058  3  0.95202

 vi33   0.92429
103
 i3  2.659%
(iii) Forward rate is f2,1 where
(1  i3 )3 1.026593
1  f 2,1    1.03000  f 2,1  3.000%
(1  i2 )2 1.024892
(iv) Reasons could include:
Expectations theory suggests that if short-term interest rates are expected to

rise then if yields are the same on both long- and short-term bonds, short-term
bonds will be more attractive and longer term bonds less attractive and so the
yields on short-term bonds will fall relative to those on long-term bonds.
[Expected higher inflation could be a reason for this but could be allowed as a
distinct point]
Page 7
Liquidity preference theory suggests that investors demand higher rates of

return for less liquid/longer term-to-maturity investments which are more
sensitive to interest rate movements.
Market segmentation with the supply of bonds being restricted at shorter terms
or some factor that leads to the demand for bonds of longer terms to be lower
Common errors on this question included assuming the price of each bond
was 100 and that the gross redemption yield of the 3-year bond was equal to
the three-year spot rate. In part (iv) many candidates just gave the names of
theories of the yield curve without explaining how this applied in this particular
scenario. Otherwise, this was the best answered question on the paper apart
from Q1.
Q7 (i) Maximum rate of return after 20 years
 
100  0.75 7 a (2)  3a (2)  130v 20
20 10
Try i = 5%:
 7  (1  1.0520 )  3  (1  1.0510 ) 
RHS = 0.75    130  1.0520
 1
2(1.05 2  1) 
 
 48.6460  48.9956  97.6417
Try i = 4%:
 7  (1  1.04 20 )  3  (1  1.04 10 ) 

RHS = 0.75    130  1.04 20
 1
2(1.04 2  1) 
 
 53.6255+59.3303  112.9558
Interpolating
100  112.9558
i  0.04  0.01  4.846%  4.8%
97.6417  112.9558
(Exact answer is 4.8338%.)
Page 8
(ii) Minimum rate of return after 10 years
In this case, the investor invests 100, receives 100 back and receives a net
income at a rate of 1.5 per half-year. The rate of return per half-year effective
is therefore 1.5 per cent.
The annual effective rate of return is 1.0152 – 1 = 3.0225%.
(iii) There is a 0.5 probability of both early redemption and of late redemption. The
expected return is therefore 0.5(4.8338%  3.0225%)  3.928%
(iv) If the investor buys the whole loan, the present value of the cash flows from
the loan is as follows (per €100 nominal):

 0.75  4 a (2)  0.5  100v10  0.5 0.75  7 a (2) v10  130v 20
10 10 
At i = 3.928% this is
1  1.0392810
3 1
 50  1.0392810
2(1.03928 2  1)
 1  1.0392810 
0.5  5.25 1.0392810  130  1.0392820 
 1
2(1.03928 2  1) 
 
 24.6575  34.0125  0.5(29.3538  60.1562)
 103.4264
This is greater than 100 and so the rate of return will be greater than 3.928%
(exact return is 4.212%).
This was the worst answered question on the paper with many candidates not
recognising that the cases where the bond is redeemed after 10 years and
after 20 years have to be calculated separately for parts (i) and (ii). If
candidates obtained answers for parts (i) and (ii) then part (iii) was usually
done well. However, few candidates recognised that substituting the return
from part (iii) into the required equation for part (iv) would lead to the required
answer.
The question did not state specifically that the coupons in the second
10 years were semi-annual although most students assumed this.
Candidates who assumed a different coupon frequency were given full credit.
Page 9
Q8 (i)
 Generally issued by commercial undertakings and other bodies.
 Shares are held by the owners of a company who receive a share in the
company’s profits in the form of dividends
 Potential for high returns relative to other asset classes…
 …but high risk particularly risk of capital losses
 Dividends are not fixed or known in advance and…
 …the proportion of profits paid out as dividends will vary from time-to-
time
 No fixed redemption date
 Lowest ranking finance issued by companies.
 Return made up of income return and capital gains.
 Initial running yield low but has potential to increase with dividend
growth…
 …in line with inflation and real growth in company earnings.
 Marketability depends on the size of the issue.
 Ordinary shareholders receive voting rights in proportion to their holding.
(ii) Let
P = price investor is willing to pay

d = next expected dividend
g = expected annual dividend growth rate
r = annual required return
t = tax rate
Then
d (1  t ) d (1  t )(1  g ) d (1  t )(1  g ) 2
P   
1 r (1  r )2 (1  r )3
d (1  t )  1  g  1  g   1  g  
2 3
 1       
1  r  1  r  1  r   1  r  
d (1  t ) 1 d (1  t )
 
1 r 1 1 g rg
1 r
(iii) d = 6p
g = 0.01
r = 0.06
t = 0.2
d (1  t ) 6(1  0.2)
P   96 p
rg 0.06  0.01
Page 10
(iv) If the share were regarded as more risky, then the required return, r, would
increase. If r were to increase, this would reduce the value of the share as r is
in the denominator (and is positive).
(v) Equation of value would be (working in money terms):
960  0.8  60v  1200v  0.25 1200  960  v

96
v
118.8
118.8
Therefore net money rate of return, i, is  1  23.75%
96
1.2375
Net real rate of return is  1  20.80%
126 123
There was an error in the paragraph prior to part (v) of this question where
the calculation was designed to be based on the purchase/sale of 1,000
shares but the question referred to the sale of “the share”. Nearly all
candidates based their calculation on the purchase/sale of the same number
of shares (whether it be 1 share or 1,000) but candidates who made a
different assumption were not penalised.
There was no split of the marks between parts (ii) and part (iii) given on the
paper. Candidates who just performed the calculation without the derivation
of the formula were give appropriate credit but a formula derivation was
required to obtain the full five marks for these parts. The question did not
state specifically that the dividends were paid annually although almost all
candidates assumed this. Candidates who assumed other payment
frequencies were given full credit.
Q9 (i) (a) The payback period is the first time at which the total incoming cash
flows are equal or greater in amount than the total outgoing cash flows.
Total incoming cash flows at the beginning of year t = 60,000t.
Determine t for which 60, 000t  1, 000, 000  t  16.67
Therefore the payback period is 16 years.
(b) The net total income received in any year from project A is never
greater than £60,000. As the costs are incurred at the beginning of the
year, there is no point at which the total income from project A is
greater than the total income from project B until the very end of the
project when the properties are sold. The payback period for B must
therefore be less than that for A.
Page 11
(ii) (a) The discounted payback period occurs where the present value (or
accumulated value) of incoming cash flows is equal to or greater than
that of outgoing cash flows for the first time.
(b) Equation of value for project B is (in £000):
60at  1, 000
1, 000 1, 000
 at    16.5016
60(1  i ) 60.6
Need to solve for t. From inspection of tables, t = 19 and so the

discounted payback period is 18 years.
(c) Again, given that the net income from project A is never greater in an
individual year, than that from project B, at no rate of interest can the
discounted value of the net income from project A be greater than that
for the income from project B.
(iii) Internal rate of return from project B is the solution to the following equation
of value (all figures in 000s):
1, 000  60a20  1, 000v 20
This can be solved by general reasoning.
As the investor invests 1,000 and receives an annual income of 60 in advance

and receives his capital back at the end, the total rate of return, d, expressed as
an effective rate of discount per annum is 6 per cent.
d 0.06
Internal rate of return is i    6.383%
1  d 0.94
(iv) If the IRR from project A is higher then it must have a net present value > zero
at a rate of interest of 6.383 per cent.
Note that v = 0.94 at i = 6.383%
Present value of costs for project A:
 1, 000  10(1  1.005v  1.0052 v 2  ...  1.00519 v19 )
 1  1.00520 v 20 
 1, 000  10  
 1  1.005v 
 1  (1.005  0.94) 20 
 1, 000  10  
 1  1.005  0.94 
Page 12
0.67946
 1, 000  10  1,122.869
0.0553
Present value of revenue for project A:
 2, 000v 20  60a(12) v  60a(12) v5 (1.005  1.0052 v    1.00515 v14 )

4 1
 2, 000v 20  60a(12) v  60a(12)1.005v5 (1  1.005v    1.00514 v14 )

4 1
 1  1.00515 v15 
 2, 000v 20  60a(12) v  60a(12)1.005v5 
4 1  1  1.005 v 
 
 1  0.94 4 
 2, 000  0.9420  60  0.94  
 12(1  (1  0.06) 12 ) 
1
 
 1  0.94   1  (1.005  0.94)15 

60  1.005  0.945   
 12(1  (1  0.06) 112 )   1  1.005  0.94 
  
 580.212  200.365  446.577  1, 227.154
NPV of project at IRR from project A is: 1,227.154 – 1,122.869 = 104.285

(= £104,285)
This is clearly positive so project A has a higher IRR.
(v) Project B would be preferred on the basis of both payback period and
discounted payback period.
However, both these measures have shortcomings. The first does not take into
account interest at all and the second does not take into account cash flows
after the discounted payback period [or in the case of project A the occurrence
of one large cash flow at the time of the discounted payback period]
Project A would be preferred on the basis of internal rate of return.
The internal rate of return measures the total return on the project and
therefore is a better decision criterion than payback period or discounted
payback period.
There may be other factors (comparison of NPVs at a particular rate of interest

or the risk of the two projects) that should be taken into account.
Page 13
Other factors could include, for example:
student’s need for return of original investment

reliability of estimates of future cashflows
It appeared that many candidates were under time pressure when attempting
this question. Nearly all candidates failed to recognise how the payments
being at the start of the year for project B would impact on the payback period
and the discounted payback period. Many candidates’ general reasoning
arguments for parts (i)(b) and (ii)(c) were unclear. In part (c), a common
mistake was to miss out the return of the original investment in the calculation
of the IRR. In part (iv), common errors were to miscount the number of terms
(for both costs and revenue). As for similar long questions in previous years,
marginal candidates would have benefited from showing their intermediate
working in greater depth and/or with greater clarity. There were a wide range
of points that could be made to score marks in part (v) but few candidates
scored well on this part.
Page 14
1
3
4
5
6
7
EXAMINATION
8
9
12 April 2016 (am)
10
12
Core Technical
13
14 Time allowed: Three hours
15
16
17 booklet.
18
19 supervisor.
20
21
22
24
25
26
27
28 question paper.
29
30 and Tables and your own electronic calculator from the approved list.
31
32
33
34
35 CT1 A2016  Institute and Faculty of Actuaries
1 List the characteristics of convertible bonds. [3]
2 An insurance company has liabilities of £6 million due in exactly 8 years’ time and a
further £11 million due in exactly 15 years’ time.
The assets held by the insurance company consist of:
 a 5-year zero-coupon bond of nominal amount £5.5088 million; and

 a 20-year zero-coupon bond of nominal amount £13.7969 million.
The current rate of interest is 8% per annum effective at all durations.
(i) Show that the first two conditions of Redington’s theory for immunisation
against small changes in the rate of interest are satisfied. [5]
(ii) Explain, without doing any further calculations, whether the insurance
company will be immunised against small changes in the rate of interest. [2]
[Total 7]
3 At time t = 0, the one-year zero-coupon yield is 4% per annum effective and the
one-year forward rate per annum effective at time t (t = 1, 2, …) is given by:
ft,1 = (4 + t)%.
(i) Determine the issue price per £100 nominal of a three-year 4% coupon bond
issued at time t = 0, paying coupons annually in arrear and redeemable at
105%. [4

(ii) Determine the three-year par yield at time t = 0. [3]
[Total 7]
4 A loan of nominal amount £100,000 is to be issued bearing coupons payable quarterly

in arrear at a rate of 7% per annum. Capital is to be redeemed at £108 per £100
nominal on a coupon date between 15 and 20 years inclusive after the date of issue.
The date of redemption is at the option of the borrower.
An investor who is liable to income tax at 25% and capital gains tax at 40% wishes to
purchase the entire loan at the date of issue.
(i) Determine the price which the investor should pay to ensure a net effective
yield of at least 5% per annum. [5]
(ii) Explain the significance of the redemption date being at the option of the
borrower in relation to your calculation in part (i). [2]
[Total 7]
CT1 A2016–2
5 A loan is to be repaid by a series of instalments payable annually in arrear for 15
years. The first instalment is £1,200 and payments increase thereafter by £250 per
annum.
Repayments are calculated using a rate of interest of 6% per annum effective.
Determine:

(i) the amount of the loan. [3]
(ii) the capital outstanding immediately after the 9th instalment has been made.
[2]
(iii) the capital and interest components of the final instalment. [2]
[Total 7]
6 The force of interest, (t), is a function of time and at any time t, measured in years, is
0.06 0t 4

(t )  0.10  0.01t 4  t  7 .
0.01t  0.04 7  t


(i) Calculate, showing all working, the value at time t = 5 of £10,000 due for
payment at time t = 10. [5]
(ii) Calculate the constant rate of discount per annum convertible monthly which
leads to the same result as in part (i). [2]
[Total 7]

7 A one-year forward contract on a share was agreed on 1 September 2015 when the
share price was £8.70 and the risk-free force of interest was 7% per annum. The stock
was expected to pay a dividend of £1.10 eight months after the date of issue.
The price of the share was £9.90 on 1 February 2016 and the risk-free force of interest
was 6.5% per annum. The dividend expectation was unchanged.
Calculate, showing all working, the value of the contract to the holder of the long
forward position on 1 February 2016. [7]

8 An individual is planning to purchase £100,000 nominal of a bond on 1 June 2016
which will be redeemable at 110% on 1 June 2020. The bond will pay coupons of 3%
per annum at the end of each year.
The individual wishes to invest the coupon payments on deposit until the bond is
redeemed. It is assumed that, in any year, there is a 55% probability that the rate of
interest will be 6% per annum effective and a 45% probability that it will be 5.5% per
annum effective. It is also assumed that the rate of interest in any one year is
independent of that in any other year.
(i) Derive the necessary formula to determine the mean value of the total
accumulated investment on 1 June 2020. [4]
(ii) Calculate the mean value of the total accumulated investment on 1 June 2020.
[2]
[Total 6]
9 In January 2014, the government of a country issued an index-linked bond with a term
of two years. Coupons were payable half-yearly in arrear, and the annual nominal
coupon rate was 6%. The redemption value, before indexing, was £100 per £100
nominal. Interest and capital payments were indexed by reference to the value of an
inflation index with a time lag of six months.
A tax-exempt investor purchased £100,000 nominal at issue and held it to redemption.

The issue price was £97 per £100 nominal.
The inflation index was as follows:
Date Inflation Index
July 2013 120.0

January 2014 122.3
July 2014 124.9
January 2015 127.2
July 2015 129.1
January 2016 131.8

(i) Set out a schedule of the investor’s cashflows, showing the amount and month
of each cashflow. [3]
(ii) Determine the annual effective real yield obtained by the investor to the
nearest 0.1% per annum. [5]
[Total 8]

CT1 A2016–4
10 The following table gives information concerning a fund held by an investment
manager:
Year 2012 2013 2014 2015

Value of fund at 30 June  12,700,000 13,000,000 14,100,000
Net cash flow received on 1 July  2,600,000 3,700,000 1,800,000
Value of fund at 31 December 12,000,000 13,500,000 12,900,000 17,200,000

(i) Calculate, to the nearest 0.1% and showing all working, the annual effective
time-weighted rate of return (TWRR) achieved by the fund during the period
from 31 December 2012 to 31 December 2015. [3]
(ii) Show that the annual effective money-weighted rate of return (MWRR)
achieved by the fund over the same period is less than the answer obtained in
part (i) above. [2]
(iii) Explain why you would expect the outcome described in part (ii) for this fund.
[2]
(iv) Explain which of the two measures referred to in parts (i) and (ii) is a better
indicator of the investment manager’s performance over the period. [2]
[Total 9]

11 An investor is considering the purchase of 10,000 ordinary shares in Enterprise plc.
Dividends from the shares are payable half-yearly in arrear. The next dividend is due
in exactly six months and is expected to be 6.5 pence per share.
The required rate of return is 6% per half-year effective and an estimated rate of
future dividend growth is 2% per half-year.

(i) Calculate, showing all working, the maximum price that the investor should
pay for the shares. [4]
As a result of a recently announced expansion plan, the investor increases the

estimated rate of future dividend growth to 2.5% per half-year.
(ii) (a) Calculate, showing all working, the maximum price the investor should
now pay for the shares.
(b) Explain the difference between your answers to part (i) and part (ii)(a).
[2]
It is rumoured that new legislation may affect the operation of Enterprise plc.
As a result, the investor decides to increase her required rate of return to 7% per
half-year effective. The estimated dividend growth rate remains at 2% per half-year
(iii) (a) Explain why it might be appropriate for the investor to increase her
required rate of return.
(b) Calculate the maximum price that the investor should now pay for the
shares.
(c) Explain the difference between your answers to part (i) and part
(iii)(b).
[3]
In the prevailing economic circumstances, investors are expecting lower inflation in

the wider economy.

As a result, the investor decides to reduce both the assumed rate of dividend growth
and her required rate of return to 1% and 5% per half-year effective respectively.

(iv) (a) Explain why it is appropriate for the investor to reduce both the future
dividend growth rate and the required rate of return in this case.
(b) Calculate the maximum price that the investor should now pay for the
shares.
(c) Explain the difference between your answers to part (i) and part
(iv)(b).
[5]
[Total 14]
CT1 A2016–6
12 (i) Show that:
an  nv n
 Ia  
n 
. [4]
A company is considering the purchase of a gold mine which has recently ceased
production.
The company forecasts that:
 the cost of re-opening the mine will be $900,000, which will be incurred
continuously over the first twelve months.
 additional costs are expected to be constant throughout the term of the project at
$200,000 per annum, excluding the first year. These are also incurred
continuously.
 after the first twelve months, the rate of revenue will grow continuously and
linearly from zero per annum to $3,600,000 per annum at a constant rate of
$300,000 per annum.
 when the rate of revenue reaches $3,600,000 per annum it will then decline
continuously and linearly at a constant rate of $150,000 per annum until it reaches
$600,000 per annum.
 when the rate of revenue declines to $600,000 per annum production will stop and
the mine will have zero value.
(ii) Determine the overall term of the project. [2]

(iii) Calculate, showing all working, the price that the company should pay in order
to earn an internal rate of return (IRR) of 25% per annum effective. [12]
[Total 18]
END OF PAPER
CT1 A2016–7
EXAMINERS’ REPORT
April 2016 (with mark allocations)

Core Technical
Introduction
exclusively.
F Layton
Chair of the Board of Examiners
June 2016


calculations but candidates are not penalised for this. However, candidates may be
penalised where excessive rounding has been used or where insufficient working is
shown.

examination
have improved their performance. Where no comment is made the question was
generally answered well by most candidates.
2. Performance was of a similar standard to most recent diets with the weaker performance
in September 2015 being an exception to the general standard. As in previous diets, the
non-numerical questions were often answered poorly by marginal candidates.
C. Pass Mark
The Pass Mark for this exam was 60%.
Page 2
Solutions
Q1 Convertible Securities
• Generally unsecured loan stocks.

• Can be converted into ordinary shares of the issuing company.
• Pay interest/coupons until conversion.
• The date of conversion might be a single date or, at the option of the holder, one
of a series of specified dates.
• Risk characteristics of convertible vary as the final date for convertibility
approaches (behaviour will tend towards the security into which it is likely to
convert)
• Generally less volatility than in the underlying share price before conversion.
• Combine lower risk of debt securities with the potential for gains from equity
investment.
• Security and marketability depend upon issuer.
• Generally provide higher income than ordinary shares and lower income than
conventional loan stock or preference shares.
• Option to convert will have time value which is reflected in price of the security.
[½ mark for each valid point]
[MAX 3]
Despite being a bookwork question, this was answered poorly. This

performance is consistent with questions in previous years on the same area
of the syllabus.
Q2 (i) PV of asset proceeds is:
5 20
VA ( 0.08 ) = 5.5088v8% + 13.7969v8% = 6.7093
PV of liability outgo is:
8 15
VL ( 0.08 ) = 6v8% + 11v8% = 6.7093 = VA ( 0.08 )
Hence, condition (1) for immunisation is satisfied. [2]
Also, DMT of asset proceeds is:
5 20
5 × 5.5088v8% + 20 × 13.7969v8%
τ A ( 0.08 ) = = 11.618
6.7093
And, DMT of liability outgo is:
8 15
8 × 6v8% + 15 × 11v8%
τ L ( 0.08 ) = = 11.618 = τ A ( 0.08 )
6.7093
Page 3
Hence, condition (2) for immunisation is also satisfied. [3]
(ii) Yes, the insurance company is immunised.
As the asset proceeds are received at times 5 and 20, whereas the liability
outgo is paid at times 8 and 15, the spread of the asset proceeds around the
DMT is greater than the spread of the liability outgo around the same DMT.
[2]
[TOTAL 7]
Part (i) was generally answered well; however, candidates must include
sufficient factors and workings to demonstrate that the respective asset and
liability values are the same for each of the two conditions. Part (ii) was often
answered poorly. To get full marks for this part, candidates were required to
make reference to the actual data in the question rather than just repeating
the theory (e.g. stating the actual figures for the spread of the assets and the
liabilities around the DMT).
4 4 4 105
Q3 (i) Issue price (per £100 nominal) = + 2
+ 3
+ [1½]
1 + ii (1 + i2 ) (1 + i3 ) (1 + i3 )3
where it is the t-year zero coupon rate at time t = 0 and we have that:
(1 + it −1 )t −1 * (1 + ft −1,1 ) = (1 + it )t
where ft−1,1 is the one-year forward rate at time t − 1
we have 1 + i1 = 1.04 (i1 is given)
(1 + i2 )2 = (1 + i1 )(1 + f1,1 )
= 1.04 *1.05
(1 + i3 )3 = (1 + i2 ) 2 (1 + f 2,1 )
= 1.04 *1.05*1.06 [1½]
 Issue Price = 4 4 4 + 105

+ +
1.04 1.04*1.05 1.04 *1.05*1.06
= £101.68 [1]
Page 4
(ii) Let yc3 be the 3 year par yield (%). Then yc3 is given by
 1 1 1  100
100 = yc3  + +  + [1½]
 1 + i1 (1 + i ) 2
(1 + i3 )  (1 + i3 )3
3
 2
 1 1 1  100
= yc3  + + +
 1.04 1.04*1.05 1.04*1.05*1.06  1.04*1.05*1.06
= yc3 *2.741205336 + 86.39159583
 yc3 = 4.9644% [1½]

[TOTAL 7]
Generally well answered.
4
 i (4) 
Q4 (i)  1 +
(4)
 = 1.05  i = 0.049089
 4 
D 0.07
(1 − t1 ) = × 0.75 = 0.04861
R 1.08
 i (4) > (1 − t1 ) g
 Capital gain on contract and we assume loan is redeemed as late as possible

(i.e. after 20 years) to obtain minimum yield. [2]
Let price of stock = P
P = 0.07 ×100000 × 0.75 × a (4) + (108000 − 0.40(108000 − P))v 20 at 5%

20
5250 a (4) + 64800 v 20

20
P=
1 − 0.40 v 20
5250 × 1.018559 × 12.4622 + 64800 × 0.37689

=
1 − 0.40 × 0.37689
= £ 107, 228.63 [3]
(above uses factors from Formulae and Tables Book – exact answer is
£107,228.67)
Page 5
(ii) As the redemption date is at the option of the borrower, it is outside the
investor’s control when the stock will be redeemed. Hence the investor must
assume a worst case scenario in pricing the loan. [2]
[TOTAL 7]
Part (i) was answered well. The reasoning of marginal candidates in part (ii)
was often unclear. The key point is that the date of redemption is out of the
control of the investor.
Q5 (i) Loan = 950 a15 + 250( Ia )15 at 6%
= 950 × 9.7122 + 250 × 67.2668
= £26,043.29
[3]
(ii) Capital outstanding after 9 payments:
3200 a6 + 250( Ia ) 6 = 3200 × 4.9173 + 250 × 16.3767 = £19,829.54

[2]
(iii) Capital outstanding after 14 payments = 4700v at 6%

= £4,433.96
= Capital in final payment
 Interest in final payment = 4700 – 4433.96
= £266.04
[2]
(above uses factors from Formulae and Tables Book – exact answers are
£26,043.34 for (i) and £19,829.61 for (ii))
[TOTAL 7]
The best answered question on the paper.
Page 6
pv = 10, 000 × exp  −  ( 0.01t − 0.04 ) dt  × exp  −  ( 0.10 − 0.01t ) dt 

10 7
Q6 (i) [1]
 7   5 
   
10   7
 0.01t 2   0.01t 2  
= 10, 000 exp× −  − 0.04t  × exp − 0.10t − 
  2  7    2  
   5
  0.01*51    0.01*24  
= 10, 000 × exp  −  − 0.04 × 3  × exp  − 0.10*2 −  
  2    2 
= 10,000exp(−0.255 + 0.12 – 0.20 + 0.12)

= 10,000exp(−0.215)
= £8,065.41 [4]
(ii) Required discount rate p.a. convertible monthly is given by
12×5
 d (12) 
10, 000 1 −  = 8, 065.41
 12 

d(12) = 4.2923% p.a. convertible monthly.

[2]
[TOTAL 7]
Generally well answered.
Q7 Forward price of the contract is:
K 0 = ( S0 − I )eδT = (8.70 − I )e0.07 [1]
where I is the present value of the income expected during the contract
−0.07×812
 I = 1.10 × e = 1.049846 [1]
 K 0 = (8.70 − 1.049846) × e0.07 = 8.204853 [½]
Forward price of contract set up at time r (where r = 5 months) is
Kr = (Sr − I r )eδ(T −r ) [1]
Page 7
where Ir is the value at time r of the income expected during the contract
−0.065× 312
= 1.10 × e = 1.082269 [1]
0.065×712
 K r = (9.90 − 1.082269)e = 9.158489 [½]
Value of original forward contract
= ( K r − K 0 )e−δ(T −r )
7
−0.065×12
= (9.158489 − 8.204853)e
= 0.918154
= £0.92 [2]
[TOTAL 7]
Although this question was answered better than similar questions in past
diets, the workings shown by marginal candidates were often unclear.
Q8 (i) Work in £000’s
Let total accumulation at 1/6/20 be X, and iy = investment return for the year
starting from 1 June 2016 + y
E ( X ) = E 3 (1 + i1 )(1 + i2 ) (1 + i3 ) + 3 (1 + i2 ) (1 + i3 ) + 3 (1 + i3 ) + 3 + 110 [1½]
Due to independence:
E ( X ) = 3  E (1 + i1 ) E (1 + i2 ) E (1 + i3 ) + E (1 + i2 ) E (1 + i3 ) + E (1 + i3 )  + 113
[1]
= 3 (1 + E [i1 ]) (1 + E [i2 ]) (1 + E [i3 ]) + (1 + E [i2 ]) (1 + E [i3 ]) + (1 + E [i3 ])  + 113

[½]
where E(iy) = 0.55 × 6% + 0.45 × 5.5%
= 5.775% [1]
Page 8
(ii) s35.775% + 113

E ( X ) = 3 
 1.057753 − 1 
= 3 + 113
 0.05775 /1.05775 
 
= 123.080 (= £123,080 for £100,000 nominal)

[2]
[TOTAL 6]
Whilst the calculations were often correct, relatively few candidates followed
the instructions to derive the required formula for these calculations. For full
marks, such derivation was required including identifying where the
independence assumption is used.
Q9 (i) Cash Flows:
Issue Price: Jan 14 −0.97×100,000 = −£97,000
122.3
Interest Payments: July 14 0.03×100,000 × = £3,057.50
120.0
124.9
Jan 15 0.03×100,000 × = £3,122.50
120.0
127.2
July 15 0.03×100,000 × = £3,180.00
120.0
129.1
Jan 16 0.03×100,000 × = £3,227.50
120.0
129.1
Capital redeemed: Jan 16 100,000 × = £107,583.33
120.0
[3]
(ii) Express all amounts in “January 2014 money”, and we get:
122.3 12 122.3
97000 = 3057.50 × v + 3122.50 × v
124.9 127.2
122.3 112 122.3

+3180.00 × v + × (107583.33 + 3227.50)v 2 [2]
129.1 131.8
1 11
 97000 = 2993.85v 2 + 3002.22v + 3012.50v 2 + 102823.71v 2 [1]
Page 9
Try 7%, RHS = 98232.04

8%, RHS = 96499.48
 98232.04 − 97000 
i = 0.07 +   × 0.01 [2]
 98232.04 − 96499.48 
= 7.7% p.a. effective real yield (exact answer is 7.708%).
[TOTAL 8]
This question seemed to strongly differentiate between stronger and weaker

candidates. Common errors from the latter included not correctly allowing for
the time lag in part (i) or not uplifting the nominal cashflows for inflation at all.
Q10 (i) TWRR is i such that:
12, 700 13, 000 14,100 17, 200

(1 + i )3 = × × ×
12, 000 12, 700 + 2, 600 13, 000 − 3, 700 14,100 + 1,800
= 1.474830  i = 13.8% [2 for formula, 1 for solution]
(ii) If the MWRR achieved by the fund were 13.8% p.a., then fund value at
31 December 2015 would be (in £000’s):
21 11 1
12000 × (1.138)3 + 2600 × (1.138) 2 − 3700 × (1.138) 2 + 1800 × (1.138) 2
=18,706 which is greater than 17,200. This means that the MWRR must be
less than 13.8% p.a. [2]
(iii) The MWRR is lower because the fund performed badly immediately after
receiving the large positive cash flow in July 2013 and also performed well
immediately after the large negative cash flow in July 2014. [2]
(iv) The TWRR is not influenced by the amount and timing of the cash flows
(which are generally considered to be outside of the control of the fund
manager) and, thus, better reflects the manager’s performance over the period.
[2]
[TOTAL 9]
Parts (i) and (ii) were answered well. In part (ii), it is not necessary to
calculate the MWRR.
As in previous diets, candidates had difficulty explaining the relative values for
the MWRR and TWRR. For full marks in part (iii), candidates needed to make
reference to the actual data in the question. In part (iv), the key point is that
Page 10
the amount and timing of the cash flows are generally considered to be
outside of the control of the fund manager.
Q11 (i) 10,000 shares give a total dividend on the next payment date of £650.
Then, working in half-year periods, we have:
( 2
V = 650 × v6% + 1.02v6% + 1.022 v6%
3
+. . . ) [2]

( ) 
2
= 650v6% × 1 + 1.02v6% + 1.02v6% + . . .
 
 1 
= 650v6% ×  
 1 −1.02v6% 
=£16,250 [2]
(ii) (a) We now have
 1 
v = 650v6% ×   = £18,571.43 [1]
 1 − 1.025v6% 
(b) The higher rate of dividend growth means that expected future
dividend income is increased and, thus, the investor is prepared to pay
a higher price to purchase the shares. [1]
(iii) (a) The rumoured change in legislation might be thought of as increasing

the uncertainty of the future growth prospects for the company
(without necessarily either increasing or decreasing them).
Thus it is appropriate that the investor requires a higher return to

compensate for this greater uncertainty. [1]
(b) We now have:

 1 
v = 650v7% ×   = £13,000 [1]
 1 − 1.02v7% 
(c) The higher risk (as reflected by the higher effective rate of return
required) means that the investor is now prepared to pay a lower
maximum price to purchase the shares. [1]
(iv) (a) Lower inflation is likely to lead to lower (nominal) profits and, thus,
lower (nominal) dividend payments.
Page 11
Also, as many investors are more concerned with real returns (i.e. in
excess of inflation), it is appropriate to reduce the effective rate of
return to reflect the lower expected inflation. [2]
(b) We now have:
 1 
v = 650v5% ×   = £16, 250 [1]
 1 − 1.01v5% 
(c) In this case, the maximum price that the investor is prepared to pay is
unchanged. Lower expected inflation leads to lower nominal dividend
payments, which are then discounted at a lower nominal interest rate.
Thus, the price is unaffected (i.e. equities are a real asset).
[2]
[TOTAL 14]
The calculations in this question were relatively simple and generally done
well. The explanatory parts of the questions were answered better than
expected.
n
n  e−δt  n e −δt
Q12 (i) ( Ia )n =  te −δt
dt = t ×  − 0 dt
 −δ  0 −δ
0
n.e−δn 1 n −δt
=− +  e dt
δ δ 0
n
n.e −δn 1  e −δt 
=− + − 
δ δ  δ 
o
n
n.e−δn 1 1 − e−δn  an − nv
=− +  =
δ δ  δ  δ
[4]
(ii) Project lasts for 33 years as follows:
Time take to reopen mine = 1 year
Time taken for net revenue to go from zero to $3,600,000 is 12 years
 3, 600, 000 
 from 300, 000 = 12 
 
Page 12
Time taken for net revenue to decline to $600,000 is 20 years
 3, 600, 000 − 600, 000 

 from 150, 000
= 20 
 
[2]
(iii) PV of reopening costs and additional costs = 700,000 a1 + 200,000 a33 at

25%
where
i
a125% = a = 1.120355 × 0.8 = 0.896284
δ 1
25% i
a33 = . a = 1.120355 × 3.9975 = 4.478619
δ 33
 PV = 627,399 + 895,724 = 1,523,123 [3]
PV of net revenue
v . 300, 000 ( Ia )
12 {
+ v13 3, 600, 000 a 20 − 150, 000 ( Ia )
20 } [2]
i
where a12 = . a12 = 1.120355 × 3.7251 = 4.173434 [1]
δ
a12 − 12v12 4.173434 − 12 × 0.06872

( Ia )12 =
δ
=
0.223144
= 15.0073 [1]
i
a20 = . a20 = 1.120355 × 3.9539 = 4.429772 [1]
δ
4.429772 − 20v 20
( Ia )20 =
δ
= 18.818324 [1]
 PV of net revenue
300, 000
= × 15.0073 + 0.05498{3, 600, 000 × 4.429772
1.25
−150, 000 × 18.818324} [1]
= 3,601,752 + 721,581 = 4,323,333 [1]
Page 13
 Price to obtain IRR of 25% p.a. is:
4,323,333 – 1,523,123 = $2,800,210. [1]
(above uses factors from Formulae and Tables Book – exact answer is
4,323,319 – 1,523,115 = $2,800,204)
[TOTAL 18]
The proof in part (i) was answered very poorly. Also, since the result is given,
candidates must provide enough steps in deriving the result to convince the
examiners that they haven’t just jumped to the result. In part (iii), the
workings of many marginal candidates were very unclear. The examiners
recommend that candidates set out their working clearly e.g. by calculating
each component of the costs and benefits separately. This enables examiners
to give full credit for correct working even if errors are made in the
calculations.
Page 14
1
3
4
5
6
EXAMINATION
7 EXAMINATION
8
9
10
Subject CT1 – Financial
Core Mathematics
Technical
12
Core Technical
13
14 Time allowed: Three hours
15
16
17 booklet.
18
19 supervisor.
20
3. You have
Mark 15 minutes
allocations are of planning
shown and reading time before the start of this examination.
in brackets.
21 You may make separate notes or write on the exam paper but not in your answer
4. booklet. Calculators
Attempt all are beginning
12 questions, not to be used
yourduring
answerthetoreading time. You
each question on will
a newthen have
page.
22 three hours to complete the paper.
24
5. Attempt all 12 questions, beginning
Graph paper your
is NOT answerfor
required to each question on a new page.
this paper.
25
27 Graph paper is NOT required for this paper.
28 question paper.
29 AT THE END OF THE EXAMINATION
30 Hand in BOTHand your answer
Tables andbooklet,
your ownwith any additional
electronic calculatorsheets firmly
from the attached,
approved list. and this
question paper.
31
32 In addition to this paper you should have available the 2002 edition of the Formulae
33
34
CT1 S2016  Institute and Faculty of Actuaries
35 CT1 S2016  Institute and Faculty of Actuaries
1 The nominal rate of interest per annum convertible quarterly is 5%.
Calculate, giving all the answers as a percentage to three decimal places:
(i) the equivalent annual force of interest. [1]
(ii) the equivalent effective rate of interest per annum. [1]
(iii) the equivalent nominal rate of discount per annum convertible monthly. [2]
[Total 4]
2 The nominal rate of interest per annum convertible quarterly is 2%.
Calculate the present value of a payment stream paid at a rate of €100 per annum,
monthly in advance for 12 years. [4]
3 Describe the characteristics of a repayment loan (or repayment mortgage). [3]
4 The following table shows the cashflows paid into a fund on three different dates,
together with the value of the fund on each date immediately before the cash flow
takes place. There were no other cashflows except on the dates shown.
1 January 2014 1 January 2015 1 January 2016
Value of fund (£m) 112 X 160

Cash flow (£m) 23 43 32
During 2014, the rate of return on the fund was 10% per annum effective.
(i) Calculate X. [1]
(ii) Calculate, showing all workings, the annual effective time weighted rate of
return on the fund over the two-year period from 1 January 2014 to 1 January
2016. [3]
[Total 4]
5 A zero-coupon bond was issued on 1 January 1975 with a redemption date of

1 January 2015. An investor bought the bond to provide a yield to maturity of 5% per
annum convertible half yearly. On a particular date the borrower defaulted, repaying
80% of the capital to all bondholders. The investor obtained a rate of return until the
date of default which was equivalent to a force of interest of 4.8% per annum.
Determine the date on which the borrower defaulted. [5]
CT1 S2016–2
6 At the beginning of 2015 a 182–day commercial bill, redeemable at £100, was
purchased for £96 at the time of issue and later sold to a second investor for £97.50.
The initial purchaser obtained a simple rate of interest of 3.5% per annum before
selling the bill.
(i) Calculate the annual simple rate of return which the initial purchaser would
have received if they had held the bill to maturity. [2]
(ii) Calculate the length of time in days for which the initial purchaser held the
bill. [2]
The second investor held the bill to maturity.
(iii) Calculate the annual effective rate of return achieved by the second investor.
[2]
[Total 6]
7 A nine-month forward contract was issued on 1 April 2015 on a share with a price of
£1.10 at that date. Dividends of £0.10 per share were expected on 1 July 2015,
1 October 2015 and 1 January 2016.
(i) Calculate, showing all workings, the forward price assuming a risk-free rate of
interest of 8% per annum convertible half-yearly and no arbitrage. [4]
(ii) Explain why you do not need to use the expected price of the share at the time
the forward matures in the calculation of the forward price. [2]
[Total 6]
8 Three bonds, each paying annual coupons in arrear of 4% and redeemable at par,
reach their redemption dates in exactly one, two and three years’ time, respectively.
The price of each bond is £96 per £100 nominal.
(i) Calculate the gross redemption yield of the three-year bond. [3]
(ii) Calculate, showing all workings, the one-year and two-year spot rates of
interest implied by the information given. [3]
(iii) Calculate the forward rate of interest applicable over the second year. [2]
(iv) Explain whether the three-year spot rate will be higher than or lower than the
three-year gross redemption yield. [2]
[Total 10]

9 An insurance company has just written single premium contracts that require it to
make payments to policyholders of £10,000,000 in five years’ time. The total single
premiums paid by policyholders amounted to £8,000,000.
The insurance company is to invest the premiums in assets that have an uncertain
return. The return from these assets in year t, it, is independent of the returns in all
previous years with a mean value of 5.5% per annum effective and a standard
deviation of 4% per annum effective. (1 + it) is lognormally distributed.
(i) Calculate, deriving all necessary formulae, the mean and standard deviation of
the accumulation of the premiums over the five-year period. [9]
A director of the company is concerned about the possibility of a considerable loss

from the investment in the assets suggested in part (i). Instead, the director suggests
investing in fixed interest securities with a guaranteed return of 4% per annum
effective.
(ii) Set out the arguments for and against the director’s position. [3]
[Total 12]
10 A particular charity invests its assets in a fund on which it has a target rate of return of
8% per annum effective. From time-to-time, the charity also invests in projects that
help achieve its charitable objectives whilst providing a rate of return. Projects that
are accepted by the charity must fulfil each of the following criteria:
1. a minimum annual effective internal rate of return of 2% less than the target return
on the investment fund.
2. a payback period of no more than ten years.
3. a positive cash flow during the fifth year or earlier.
The charity is considering investing in a social enterprise project that involves

providing loans to farmers in low-income countries to help them develop better
resilience against poor weather conditions. The details are as follows:
 The project involves making loans of £1m at the start of each year for three years,
the first loan being made at the beginning of 2017.
 The loans will be paid back from the extra income obtained by the farmers from
the beginning of 2020.
 The repayments in each year will be through level monthly instalments paid in
advance with the rate of payment of the instalments increasing by 1% per year for
10 years after which the payments stop.
 The annual rate of repayment in 2020 will be £495,000.
 The charity will also incur costs at the end of each of the years in which income is
received of £50,000 per annum.
CT1 S2016–4
(i) Explain why, in general, the payback period is not an appropriate decision
criterion for an investment project. [2]
(ii) Determine which of the three criteria used by the charity are met in this case.
[12]
[Total 14]
11 The government of a heavily indebted country has a range of bonds currently in issue.
These include bonds with nominal amounts outstanding of £4bn and £5bn with terms
to redemption of exactly three years and ten years respectively from the current time.
Both bonds pay annual coupons in arrear of 4%. The government is negotiating a
restructuring of its debt portfolio and proposes to transform the three and ten year
bonds into perpetuities paying an annual coupon of 5% in arrear. The yield curve is
currently flat with gross redemption yields at 6% per annum effective.
(i) Calculate, showing all workings, the duration of the current portfolio of three-
year and ten-year bonds. [7]
(ii) Calculate, showing all workings, the duration of the proposed portfolio of
bonds. [4]
The government’s objective is that the present value of the proposed portfolio of
bonds will be 80% of the present value of the current portfolio of three-year and ten-
year bonds.
(iii) Determine the nominal amount of the new bonds that the government will
have to issue to achieve the objective. [2]
[Total 13]

12 The force of interest, δ(t), is a function of time and at any time t (measured in years) is
given by:
0.03 for 0  t  10

(t )  at for 10  t  20
bt for t  20

where a and b are constants.
The present value of £100 due at time 20 is 50.
(i) Calculate a. [5]
The present value of £100 due at time 28 is 40.
(ii) Calculate b. [4]
(iii) Calculate the equivalent annual effective rate of discount from time 0 to time
28. [2]
A continuous payment stream is paid at the rate of e–0.04t per annum between t = 3 and
t = 7.
(iv) (a) Calculate, showing all workings, the present value of the payment
stream.
(b) Determine the level continuous payment stream per annum from time
t = 3 to time t = 7 that would provide the same present value as the
answer in part (iv)(a) above. [8]
[Total 19]
END OF PAPER
CT1 S2016–6
EXAMINERS’ REPORT
September 2016

Core Technical
Introduction
exclusively.
Luke Hatter
Chair of the Board of Examiners
December 2016


calculations but candidates are not penalised for this. However, candidates may lose
marks where excessive rounding has been used or where insufficient working is shown.

examination
have improved their performance. Where no comment is made, the question was
generally answered well by most candidates. The examiners look most closely at the
performance of the candidates close to the pass mark and the comments therefore often
relate to those candidates.
2. Performance was very slightly weaker when compared with most recent diets. As in
previous diets, the non-numerical questions were often answered poorly by marginal
candidates.
C. Pass Mark
The Pass Mark for this exam was 60.
Page 2
Solutions
Q1 (i) eδ 4 = 1.0125  δ = 4 × ln1.0125 = 0.0496901 = 4.969% [1]
(ii) 1 + i = 1.01254  i = 0.0509453 = 5.095% [1]
(iii) From (i) (though could be done in other ways)
 d (12 ) 
1 −  = e−δ 12 = e−0.0041408 = 0.9958677  d (12 ) = 0.049587 = 4.959%
 12 
 
[2]
[Total 4]
This was generally answered well although many candidates ignored the
specific rounding instructions or rounded incorrectly.
Q2 Various approaches (e.g. effective interest period can be changed etc.).

Work in quarters. Interest rate per quarter = 0.5%. Rate of payment per quarter = 25.
Number of quarters = 48.
i
PV = 25a( ) = 25
3
a [2]
48
d ( 3) 48
3
( −1
)
d ( ) = 3 1 − 1.005 3 = 0.0049834, a48 = 42.5803 [1]
Therefore, PV = 25 × (0.005/0.0049834) × 42.5803 = €1,068.05 [1]

[Total 4]
Generally well answered
Q3 A loan repayable by a series of payments at fixed times set in advance.
Typically issued by banks and building societies
Typically long-term …
…e,g. used to fund house purchase
…and secured against the property
Each payment contains an element to pay interest on the loan with the remainder
being used to repay capital
Page 3
In its simplest form, the interest rate will be fixed …

….and the payments will be of fixed equal amounts.
The interest payment portion of the repayments will fall over time…
… and the capital payments will rise over time.
Risk that borrower defaults on loan
Complications might be added such as (i) allowing the loan to be repaid early or (ii)
allowing the interest rate to vary
[½ mark for each point]
[Max 3]
[Total 3]
Despite being a bookwork question, this was the worst answered question on
the paper. It was not necessary to make all the above points for full marks.
Q4 (i) X = (112 + 23) × 1.1 = £148.5m [1]
(ii) TWRR is found from
148.5 160
(1 + i )2 = = 0.91906  i = −0.04132 = −4.132% [3]
135 148.5 + 43
[Total 4]
A significant number of marginal candidates failed to answer part (i) correctly.
Q5 Let original price of zero coupon bond = P
P = 100v80 at 2.5%
 P = 100 × 0.13870 = 13.87 [2]
Equation of value for the purchaser:
13.87eδt = 80 [1]
ln ( 80 13.67 ) ln 5.7678
t= t = = 36.506 years [1]
δ 0.048
Page 4
0.506 years is 185 days. There are 181 days to the end of June. Default is therefore
on 4 July 2011. [1]
[Total 5]
This question was answered poorly with many candidates not able to
formulate separate equations of value for:
• the original terms to determine the issue price.

• the revised terms to determine the date of default.
Q6 (i) Simple rate of return is (100 – 96)/96 = 0.041666 [1]
Expressed as an annual rate, this is: 0.041666 × (365/182) = 8.3562% [1]
(ii) Let the time in years = t
(97.5 – 96)/96 = 0.035t [1]
t = (97.5 – 96)/(0.035 × 96) = 0.44643 years = 163 days [1]
(iii) Equation of value for the second investor:
97.5(1 + i)(182–163)/365 = 100 [1]
365
19 100  100  19
(1 + i ) 365
= i=  − 1 = 62.640% [1]
97.5  97.5 
[Total 6]
Parts (i) and (ii) were very well answered. In part (iii), some candidates
continued to assume a simple rate of return was required. Alternative
answers to part (iii) based on different rounding of the answer in part (ii) were
given full credit.
Q7 (i) Present value of dividends, I, is:
(
0.1 v
1
4 +v
1
2 +v
3
4
)
Calculated at i′% when 1 + i′ = 1.042 = 1.0816
So I = 0.1 (1.0816–0.25 + 1.0816–0.5 + 1.0816–0.75) = 0.288499 [2]
Page 5
Hence, forward price, K, is:
K = (1.1 − 0.288499 ) × 1.08160.75 = 0.86068 = 86.068 p [2]
(ii) The price of the forward can be determined from the price of the share (for
which it is a close substitute). The forward is like the share but with delayed
settlement and without dividends. [Could also be said that the price of the
share already takes into account expectations.] [2]
[Total 6]
Part (i) was answered well although some candidates ignored the fact that the
interest rate given was a convertible half-yearly rate. Part (ii) was answered
less well with the arguments of many marginal candidates being very unclear.
Q8 (i) 96 = 4a3 + 100v3 [1]
Try 6% RHS = 94.654 [½]
Try 5% RHS = 97.2768 [½]
Interpolation gives
97.2768 − 96
i ≈ 0.05 + 0.01× = 0.0549 ≈ 5.5% [1]
97.2768 − 94.6540
104
Then 96 = 104v at i1  1 + i1 =  i1 = 8.333% [1]
96
2 104 104
96 = 4vi1 +104vi22  (1 + i2 ) = =  i2 = 6.145% [2]
96 − 4vi1 96 − 3.69231
(iii) Let the forward rate be f1,1
(1 + i2 )2 = (1 + i1 ) (1 + f1,1 ) [1]
 1.061452 = 1.08333 × (1 + f1,1 )  f1,1 = 0.04000 = 4% [1]
(iv) The three year gross redemption yield is a complex form of weighted average
of the three spot rates. [1]
Page 6
The one-year spot rate is over 8%, the two-year rate is over 6% and the gross
redemption yield is 5.5%. Therefore, the three-year rate must be less than
5.5% if the weighted average is 5.5%. [1]
[Total 10]
Part (i), (ii) and (iii) were generally answered well, although in part (iii) some
candidates were not clear as to the forward rate required by the question.
Part (iv) was very poorly answered. For this part no marks were available for
calculation without explanation.
Q9 (i) Let S n = Accumulated value at time n of £1 invested at time 0
Sn = (1 + i1 )(1 + i2 ) .... (1 + in )
 E [ Sn ] = E (1 + i1 )(1 + i2 ) .... (1 + in ) 
= E (1 + i1 ) . E (1 + i2 ) .... .E (1 + in ) by independence
and E (1 + it ) = 1 + E ( it ) = 1 + j
n
Hence E ( Sn ) = (1 + j )
Now
Var [ Sn ] = E  Sn2  − ( E [ Sn ])
2
 
E  Sn2  = E (1 + i1 ) (1 + i2 ) .... (1 + in ) 

2 2 2
   
= E (1 + i1 )  . E (1 + i2 )  .... .E (1 + in ) 

2 2 2
[1]
     
by independence [½]
and

2
  (  ) ( )
E (1 + it )  = E  1 + 2it + it2  = 1 + 2 E ( it ) + E it2
( ) 2
( )
and Var [it ] = s 2 = E it2 −  E ( it )  = E it2 − j 2
( )
 E it2 = s 2 + j 2 [1]
Page 7
Hence
( )
n
E  Sn2  = 1 + 2 j + j 2 + s 2
 
( )
n 2n
And Var [ Sn ] = 1 + 2 j + j 2 + s 2 − (1 + j ) [1]
Hence mean accumulation = 8, 000, 000E ( S5 ) [½]
5
= 8, 000, 000 (1.055 ) = £10, 455, 680 [1]
Standard deviation of accumulation = 8, 000, 000 Var ( S5 ) [½]
( )
5 10
= 8, 000, 000 1 + 2 × 0.055 + 0.0552 + 0.042 − (1.055 )
= 8, 000, 000 1.7204573 − 1.7081445 = 8, 000, 000 × 0.01231284
= £887, 706 [2]
Alternative Solution
(1+it) ~ lognormal (µ,σ2)
ln(1 + it ) ~ N (μ, σ2 )
ln(1 + it )5 = ln(1 + it ) + ln(1 + it ) +  + ln(1 + it ) ~ N (5μ,5σ2 )
Given assumption that they are independent and identically distributed

∴ (1 + it )5 ~ lognormal (5μ,5σ2 ) [2]
 σ2 
E (1 + it ) = exp  μ +  = 1.055 [1]
 2 

Var(1 + it ) = exp(2μ + σ2 )  exp(σ2 ) − 1 = 0.042 [1]

 
0.042
1.055 2  ( )
= exp σ2 − 1  σ2 = 0.0014365

[1]
 0.0014360 
exp  μ +  = 1.055 
 2 
Page 8
0.0014365
μ = ln1.055 − = 0.052823 [1]
2
5µ = 0.264113
5σ2 = 0.0071825.
Let S5 be the accumulation of one unit after five years:
 5σ 2   0.0071825 
E ( S5 ) = exp  5 × μ +  = exp  0.264113 + 
 2   2 

=1.30696 [½]
 ( )
Var( S5 ) = exp(2 × 5μ + 5σ 2 )  exp 5σ 2 − 1

= exp(2 × 0.264113 + 0.0071825) . (exp 0.0071825 –1)
= exp 0.53541 (exp 0.0071825 – 1)
= 0.01231284 [½]
8,000,000 × 1.30696 = £10,455,680. [1]
8,000,000 × 0.0123128490.5 = £887,706 [1]
(ii) If the company invested in fixed-interest securities, it would obtain a

guaranteed accumulation of £8,000,000 * (1.04)5 = £9,733,223. In one sense,
there is a 100% probability that a loss will be made and therefore the policy is
unwise. [1]
The “risky” investment strategy leads to an expected profit. [1]
Page 9
On the other hand, the standard deviation of the accumulation from the risky
investment strategy will be higher than investing in the fixed-interest
securities. Whilst there is a chance of an even greater profit from this strategy,
there is also a chance of a more considerable loss than from investing in fixed-
interest securities. [1]
[Total 12]
Many candidates either ignored the requirement in part (i) to derive the
necessary formulae or had difficulty in performing the derivation often trying to
combine the two methods above without success. Part (ii) was better
answered than the other explanation questions on the paper.
Q10 (i) The payback period simply tells an investor when the total cash inflows from
the investment have exceeded the total cash outflows. This tells the investor
nothing about the overall profitability of the project. [2]
(ii) The present value of outgoing cash flows at a rate of return of 6% per annum
effective is as follows (in £m):
(
a3 + 0.05 a13 − a3 )
= 1.06 × 2.6730 + 0.05(8.8527 – 2.6730) = 3.14238 [2]
The present value of the incoming cash flows is as follows (in £m):
(
= 0.495v3a(12) 1 + 1.01v + 1.012 v 2 + ... + 1.019 v9
1 )
= 0.495v3
d
d
(12 ) (
1 + 1.01v + 1.012 v 2 + ... + 1.019 v9 )
= 0.495 × 0.83962 × 0.973784 × (1 – 1.0110/1.0610) / (1 – 1.01/1.06)
= 0.404716 × 8.12352 = 3.2877 [3½]
NPV of cash flows at 6% = 3.2877 – 3.1424 = £0.1453m = £145,300 [1]
The project has a positive NPV at 6% and therefore an IRR higher than 6%
and the first criteria is met. [½]
By the end of the 10th year, the total outgoing cash flows will have been:
£3,000,000 plus 7 × £50,000 or £3,350,000. [1]
Total incoming cash flows are:
495,000 × (1 + 1.01 + 1.012 +...+ 1.016) (i.e. rate of payment of £495,000

rising by 1% per year for seven years). [1]
Page 10
Geometric progression with common ratio 1.01 and seven terms
= 495,000(1 – 1.017)/(1 – 1.01) = £3,570,700 [1]
This is greater than total outgoing cash flows and therefore second criterion is
met. [½]
There is clearly a positive cash flow in the fifth year as the incoming cash
flows will be greater than £495,000 and the outgoing cash flows will be
£50,000. [1]
Therefore final criterion is met. [½]

[Total 14]
This was the worst answered of the longer questions. The examiners strongly
recommend that candidates take a systematic approach to the question and
e.g. derive the PVs of the outgo and income separately. Marginal candidates
would have benefited from showing their intermediate working in greater
depth and/or with greater clarity, explaining all steps.
Candidates who assumed that the repayments continued for 11 years, rather
than 10, were not penalised.
Q11 (i) Duration =  tCt vt  Ct vt

t t
 3   10 
  4 × 0.04 × tv  +   5 × 0.04 × tv  + 4 ×1× 3v + 5 ×1×10v
t t 3 10
=  t =1   t =1 
 3   10 
  4 × 0.04 × v  +   5 × 0.04 × v  + 4 ×1× v + 5 ×1× v
t t 3 10
 t =1   t =1 
0.16 ( Ia )3 + 0.20 ( Ia )10 + 12v3 + 50v10

= [4]
0.16a3 + 0.20a10 + 4v3 + 5v10
Therefore, duration
0.16 × 5.2422 + 0.20 × 36.9624 + 12 × 0.83962 + 50 × 0.55839 46.2264

= =
0.16 × 2.6730 + 0.20 × 7.3601 + 4 × 0.83962 + 5 × 0.55839 8.05015
= 5.742 years [3]
Page 11
1
(ii) Present value of new portfolio per unit nominal = [1]
i
d 1
  1
Volatility of new portfolio per unit nominal = − di  i  = [1]
1 i
i
Duration of new portfolio, applying equation above is

1 + i 1.06
volatility × (1 + i ) = =
i 0.06
= 17.666 years [2]
(iii) Present value of existing bonds:
= £8.05013bn [½]
Let the nominal amount of new bonds issued = X
0.05 X
Present value of new bonds = 0.05 Xa∞ =
0.06
0.05 X
 = 0.8 × 8.05013  X = £7.728bn
0.06
[1½]
[Total 13]
In part (i), many candidates incorrectly calculated DMTs separately for the two
bonds which simplified the question and did not produce the DMT of the
whole portfolio. Part (ii) was poorly answered with many candidates not
recognising the relationship between DMT and volatility. It is also important in
such questions to state the time units in the final answer. Part (iii) did seem to
act as a differentiator between candidates, with the strongest candidates able
to proceed clearly through the question.
Q12 (i) 50 = 100v ( 20 )
 10   20 
where v ( 20 ) = exp  −  0.03dt  exp  −  at dt  [3]
   
 0   10 
20
10  at 2 
= exp [ −0.03t ]0
exp  − 
 2 10
Page 12
= e−0.3e−150 a = e−0.3−150a = 0.5 [1]
ln 2 − 0.3
a= = 0.0026210 [1]
150
(ii) 40 = 100v ( 28)

 28 
where v ( 28 ) = v ( 20 ) exp  −  bt dt  [1]
 
 20 
28
 −bt 2 
= −0.5exp  
 2  20
= 0.5e−192b = 0.4 [2]
− ln 0.8
b= = 0.0011622 [1]
192
(iii) Equivalent annual effective rate of discount can be found from:
28 28
100 (1 − d ) = 40  (1 − d ) = 0.4 [1]
 d = 0.032195 = 3.220% [1]
7 7 7
(iv) (a) We require:  ρ ( t ) v ( t ) dt =  e −0.04t −0.03t
e dt =  e−0.07t dt [1½]
3 3 3
e −0.07t  7
=  [1]
 −0.07  3
= −8.751806 + 11.579775 = 2.827969 [1½]
(b) The present value of the payment stream 2.827969 = X a7 − a3 ( )

where X is the continuous payment stream using δ = 0.03. [2]
2.827969 2.827969
X= =
a7 − a3  1 − e−0.03×7   1 − e−0.03×3 
  −  
 0.03   0.03 
2.827969
= = 0.82092 [2]
6.31386 − 2.86896
[Total 19]
Page 13
This was well answered apart from part (iv)(b). It was pleasing to see many
candidates using good exam technique to leave enough time for this question
which proved to be more straightforward than the other longer questions.
Page 14

Ilovepdf Merged 2

Uploaded by

Copyright:

Available Formats

Ilovepdf Merged 2

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ilovepdf Merged 2

Uploaded by

Copyright:

Available Formats

INSTITUTE AND FACULTY OF ACTUARIES

Subject CT1 — Financial Mathematics

© Institute and Faculty of Actuaries

1 (i) We want 1000e

∫3 ( 0.04 + 0.003s ) ds = ⎡⎣0.04s + 0.001 s ⎤⎦3

= 0.325 – 0.147 = 0.178

= 0.805 − 0.425 = 0.380

2 Forward price of the contract is K 0 = ( S0 − I ) eδT = ( 68 − I ) e0.14×1

Forward price a new contract issued at time r (3 months) is

Value of original contract = ( K r − K 0 ) e ( )

121.4 121.4 2 121.4 3

at i′ % where i′ = real yield

135, 000 = (7635.828 + 7737.178 + 7702.379 + 7853.820 + 126015.077) ν5

Try i′ = 3%, RHS = 137434.955

Try i′ = 3.5%, RHS = 134492.919

= 0.03414 (i.e. 3.4% p.a.)

(ii) The term:

4 (i) We can find forward rates f2,1 and f2,2 from:

⇒ (1.033) = (1.032 ) (1 + f 2,1 )

⇒ f 2,1 = 3.50029 % p.a.

and (1.034 ) = (1.032 ) (1 + f 2,2 )

⇒ f 2,2 = 3.60039 % p.a.

(ii) (a) Price per £100 nominal

= 4 ( 0.969932 + 0.938946 + 0.907192 ) + 115 × 0.907192

(b) Let yc3 = 3 − year par yield

1 = yc3 ( 0.969932 + 0.938946 + 0.907192 ) + 0.907192

i.e. 3.2957% p.a.

So i ( ) > g (1 − t1 ) ⇒ there is a capital gain on the contract

(iii) If A is the price per £100 of loan:

= 4.8 × 1.012348 × 14.0939 × (1.05 )12 + (105 − 0.35 (105 − A ) ) × 0.29771

⇒ Price of loan = £99,759

6 (i) MWRR is given by:

Try 11%, LHS = 16.996

Try 12%, LHS = 17.132

(ii) TWRR is given by:

= 39.7445 X + 2, 616.695465 + 1, 627.606705 + 907.1436682 + 382.3097071

60, 000 − 5,533.756

= £1,370.41 per quarter

60, 000 × 0.02 = £1, 200

Hence, capital repaid on 1 October 1998 is

1370.41 − 1200 = £170.41

Therefore, interest paid on 1 January 1999 is

( 60000 − 170.41) × 0.02 = 1196.59

1370.41 − 1196.59 = 173.82

(iii) Loan outstanding at 1 July 2011 (after repayment of instalment)

= 1670.41 a12 + 1770.41 ν12 a16 at 2%

= 1670.41×10.5753 + 1770.41× 0.78849 × 13.5777

(ii) Work in £millions

Let proceeds from four-year bond = X

Require PV Assets = PV Liabilities

X ν 4 + Y ν 20 = 10ν3 + 20ν 6 (1)

Require DMT Assets = DMT Liabilities

⇒ 4 X ν 4 + 20Y ν 20 = 30ν3 + 120ν 6 (2)

⇒ 16Yν20 = 40ν6 − 10ν3

40ν 6 − 10ν3 31.61258 − 8.88996

10ν3 + 20ν 6 − Y ν 20 8.88996 + 15.80629 − 1.42016

Require Convexity of Assets > Convexity of Liabilities

⇒ 20 X ν 6 + 420Y ν 22 > 120ν5 + 840ν8

LHS = 981.869 > 712.411 = RHS

Therefore condition is satisfied and so above strategy will immunise company