The Theory of Interest - Solutions Manual

Chapter 2
1. The quarterly interest rate is
( )
i 4 .06
j= = = .015
4 4
and all time periods are measured in quarters. Using the end of the third year as the
comparison date
3000 (1 + j ) + X = 2000v 4 + 5000v 28
12

X = 2000 (.94218 ) + 5000 (.65910 ) − 3000 (1.19562 )

= $1593.00.

2. The monthly interest rate is

( )
i 12 .18
j= = = .015.
12 12
Using the end of the third month as the comparison date
X = 1000 (1 + j ) − 200 (1 + j ) − 300 (1 + j )
3 2

= 1000 (1.04568 ) − 200 (1.03023) − 300 (1.015 )

= $535.13.

3. We have
200v 5 + 500v10 = 400.94v 5
v10 = .40188v 5
v 5 = .40188 or (1 + i )5 = 2.4883.
Now using time t = 10 as the comparison date
P = 100 (1 + i ) + 120 (1 + i )
10 5

= 100 ( 2.4883) + 120 ( 2.4883) = $917.76.

2

4. The quarterly discount rate is 1/41 and the quarterly discount factor is
1 − 1/ 41 = 40 / 41 . The three deposits accumulate for 24, 16, and 8 quarters,
respectively. Thus,
⎡ ⎛ 40 ⎞
−24
3 ⎛ 40 ⎞
−16
5 ⎛ 40 ⎞ ⎤
−8

A ( 28 ) = 100 ⎢(1.025 ) ⎜ ⎟ + (1.025 ) ⎜ ⎟ + (1.025 ) ⎜ ⎟ ⎥ .

⎣ ⎝ 41 ⎠ ⎝ 41 ⎠ ⎝ 41 ⎠ ⎦
However,
−1
⎛ 40 ⎞
⎜ ⎟ = 1.025
⎝ 41 ⎠
so that
A ( 28 ) = 100 ⎡⎣(1.025 ) + (1.025 ) + (1.025) ⎤⎦ = $483.11 .
25 19 13

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The Theory of Interest - Solutions Manual Chapter 2

5. (a) At time t = 10 , we have

X = 100 (1 + 10i ) + 100 (1 + 5i ) with i = .05
= 200 + 1500 (.05 ) = $275.
(b) At time t = 15 , we have
X (1 + 5i ) = 100 (1 + 15i ) + 100 (1 + 10i ) with i = .05
X (1.25 ) = 200 + 2500 (.05 ) = 325
and
325
X= = $260 .
1.25

6. The given equation of value is

1000 (1.06 ) = 2000 (1.04 )
n n

so that
n
⎛ 1.06 ⎞
⎜ ⎟ =2
⎝ 1.04 ⎠
n [ ln1.06 − ln1.04] = ln 2
and
.693147
n= = 36.4 years .
.058269 − .039221

7. The given equation of value is

3000 + 2000v 2 = 5000v n + 5000v n +5
3000 + 2000 (1 − d ) = 5000 (1 − d ) ⎡⎣1 + (1 − d ) ⎤⎦
2 n 5

and 3000 + 2000 (.94 ) = 5000 (.94 ) ⎡⎣1 + (.94 ) ⎤⎦

2 n 5

since d = .06 . Simplifying, we have

4767.20 = 8669.52 (.94 )
n

(.94 )n = 4767.20 = .54988

8669.52
n ln (.94 ) = ln (.54988 )
ln (.54988 )
and n = = 9.66 years.
ln (.94 )

8. The given equation of value is

100 = 100v n + 100v 2 n
which is a quadratic in v n . Solving

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The Theory of Interest - Solutions Manual Chapter 2

v2n + vn − 1 = 0
−1 ± 1 − ( 4 )(1)( −1) −1 + 5
vn = =
2 2
= .618034 rejecting the negative root.
We are given i = .08 , so that
(1.08 )n = 1/ .61803 = 1.618034
ln1.618034
and n = = 6.25 years.
ln1.08

9. Applying formula (2.2)

n 2 + ( 2n ) + " + ( n 2 ) n 2 (1 + 22 + " + n 2 )
2 2

t = = .
n + 2n + " + n 2 n (1 + 2 + " + n )
We now apply the formulas for the sum of the first n positive integers and their
squares (see Appendix C) to obtain
n 2 ( 16 ) ( n )( n + 1)( 2n + 1) 1 2n 2 + n
( )( )
= n 2n + 1 = .
n ( 12 ) ( n )( n + 1) 3 3

10. We parallel the derivation of formula (2.4)

ln 3
(1 + i )n = 3 or n =
ln (1 + i )
and approximating i by .08, we obtain
ln 3 .08 1.098612 .08
n≈ ⋅ = ⋅
i ln (1.08 ) i .076961
1.14
= or a rule of 114, i.e. n = 114.
i

11. Use time t = 10 as the comparison date

A: 10 [1 + (10 )(.11)] + 30 [1 + ( 5 )(.11)] = 67.5
10 − n 10 − 2 n
B: 10 (1.0915) + 30 (1.0915 ) = 67.5
−
10v n + 30v 2 n = 67.5 (1.0915 ) = 28.12331
10

which gives the quadratic

v 2 n + .33333v n − .93744 = 0.
Solving
−.33333 ± (.33333) − ( 4 )(1) ( −.93744 )
2

v =
n
= .81579
2

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The Theory of Interest - Solutions Manual Chapter 2

and
ln (.81579 )
n= = 2.33 years.
− ln (1.0915 )

12. Let t measure time in years. Then

a A ( t ) = (1.01)
12 t
and
t

a B (t ) = e∫ 0
r / 6 dr
= et /12 .
2

Equate the two expressions and solve for t

(1.01)12t = et or (1.01) = et
144 t
2 2
/12

144t ln (1.01) = t 2
and t = 144 ln (1.01) = 1.43 years.

13. Let j be the semiannual interest rate. We have

1000 (1 + j ) = 3000
30

and j = 31/ 30 − 1 = .0373.

The answer is
i 2 = 2 j = 2 (.0373) = .0746, or 7.46%.
( )

14. The given equation of value is

300 (1 + i ) + 200 (1 + i ) + 100 = 700.
2

Simplifying, we get a quadratic

3 (1 + 2i + i 2 ) + 2 (1 + i ) − 6 = 0
3i 2 + 8i − 1 = 0.
Solving the quadratic
−8 ± 82 − ( 4 ) ( 3) ( −1) −8 ± 76
i= =
( 2 ) ( 3) 6
−8 + 2 19 19 − 4
= = rejecting the negative root.
6 3

15. The given equation of value is

100 + 200v n + 300v 2 n = 600v10 .
Substituting the given value of v n

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The Theory of Interest - Solutions Manual Chapter 2

100 + 200 (.75941) + 300 (.75941) = 600v10

2

v10 = .708155 or (1 + i )10 = 1.41212

and i = (1.41212 ) − 1 = .0351, or 3.51%.
.1

16. The total amount of interest equals

1000i (1 + 2 + " + 10 ) = 55, 000i.
Thus, we have
1000 + 55,000i = 1825
1825
and i = = .015, or 1.5%.
55,000

17. We have
10 10

a (10 ) = e ∫ 0 = e∫ 0
δ t dt ktdt
= e50 k = 2
so that
ln 2
50k = ln 2 and k = .
50

18. We will use i to represent both the interest rate and the discount rate, which are not
equivalent. We have
(1 + i )3 + (1 − i )3 = 2.0096
(1 + 3i + 3i 2 + i 3 ) + (1 − 3i + 3i 2 − i 3 ) = 2.0096
2 + 6i 2 = 2.0096 or 6i 2 = .0096
i 2 = .0016 and i = .04, or 4%.

19. (a) Using Appendix A December 7 is Day 341

August 8 is Day 220.
We then have
1941: 24 = 365 − 341
1942 : 365
1943: 365
1944: 366 (leap year)
1945: 220
Total = 1340 days.

(b) Applying formula (2.5)

360 (Y2 − Y1 ) + 30 ( M 2 − M 1 ) + ( D2 − D1 )
= 360 (1945 − 1941) + 30 ( 8 − 12 ) + ( 8 − 7 ) = 1321 days.

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The Theory of Interest - Solutions Manual Chapter 2

⎛ 62 ⎞
20. (a) I = (10,000 ) (.06 ) ⎜ ⎟ = $101.92.
⎝ 365 ⎠
⎛ 60 ⎞
(b) I = (10,000 ) (.06 ) ⎜ ⎟ = $100.00.
⎝ 360 ⎠
⎛ 62 ⎞
(c) I = (10,000 ) (.06 ) ⎜ ⎟ = $103.33.
⎝ 360 ⎠

⎛ n ⎞
21. (a) Bankers Rule: I = Pr ⎜ ⎟
⎝ 360 ⎠
⎛ n ⎞
Exact simple interest: I = Pr ⎜ ⎟
⎝ 365 ⎠
where n is the exact number of days in both. Clearly, the Banker’s Rule always
gives a larger answer since it has the smaller denominator and thus is more
favorable to the lender.
⎛ n* ⎞
(b) Ordinary simple interest: I = Pr ⎜ ⎟
⎝ 360 ⎠
where n* uses 30-day months. Usually, n ≥ n* giving a larger answer which is
more favorable to the lender.
(c) Invest for the month of February.

22. (a) The quarterly discount rate is

(100 − 96 ) /100 = .04. Thus,
d 4 = 4 (.04 ) = .16, or 16%.
( )

(b) With an effective rate of interest

96 (1 + i ) = 100
.25

4
⎛ 100 ⎞
and i = ⎜ ⎟ − 1 = .1774, or 17.74%.
⎝ 96 ⎠

23. (a) Option A - 7% for six months:

(1.07 ).5 = 1.03441.
Option B - 9% for three months:
(1.09 ).25 = 1.02178.
The ratio is
1.03441
= 1.0124.
1.02178

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The Theory of Interest - Solutions Manual Chapter 2

(b) Option A - 7% for 18 months:

(1.07 )1.5 = 1.10682.
Option B - 9% for 15 months:
(1.07 )1.25 = 1.11374.
The ratio is
1.10682
= .9938.
1.11374

24. The monthly interest rates are:

.054 .054 − .018
y1 = = .0045 and y2 = = .003.
12 12
The 24-month CD is redeemed four months early, so the student will earn 16 months
at .0045 and 4 months at .003. The answer is
5000 (1.0045 ) (1.003) = $5437.17.
16 4

25. The APR = 5.1% compounded daily. The APY is obtained from
365
⎛ .051 ⎞
1 + i = ⎜1 + ⎟ = 1.05232
⎝ 365 ⎠
or APY = .05232. The ratio is
APY .05232
= = 1.0259.
APR .051
Note that the term “APR” is used for convenience, but in practice this term is typically
used only with consumer loans.

26. (a) No bonus is paid, so i = .0700, or 7.00%.

(b) The accumulated value is (1.07 ) (1.02 ) = 1.24954, so the yield rate is given by
3

(1 + i )3 = 1.24954 or i = (1.24954 ) 3 − 1 = .0771, or 7.71%.

1

(c) The accumulated value is

(1.07 )3 (1.02 )(1.07 ) = (1.07 )4 (1.02 ) = 1.33701,
so the yield rate is given by
(1 + i )3 = 1.33701 or i = (1.33701) 3 − 1 = .0753, or 7.53%.
1

27. This exercise is asking for the combination of CD durations that will maximize the
accumulated value over six years. All interest rates are convertible semiannually.
Various combinations are analyzed below:

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The Theory of Interest - Solutions Manual Chapter 2

4-year/2-year: 1000 (1.04 ) (1.03) = 1540.34.

8 4

3-year/3-year: 1000 (1.035 ) = 1511.08.

12

All other accumulations involving shorter-term CD’s are obviously inferior. The
maximum value is $1540.34.

28. Let the purchase price be R. The customer has two options:
One: Pay .9R in two months.
Two: Pay (1 − .01X ) R immediately.
The customer will be indifferent if these two present values are equal. We have
(1 − .01X ) R = .9 R (1.08 )−
1
6

− 16
1 − .01X = .9 (1.08 ) = .88853
and
X = 100 (1 − .88853) = 11.15%.

29. Let the retail price be R. The retailer has two options:
One: Pay .70R immediately.
Two: Pay .75R in six months.
The retailer will be indifferent if these two present values are equal. We have
.70 R = .75 R (1 + i )
−.5

.70 (1 + i ) = .75
.5

and
2
⎛ .75 ⎞
i=⎜ ⎟ − 1 = .1480, or 14.80%.
⎝ .70 ⎠

30. At time 5 years

1000 (1 + i / 2 ) = X .
10

At time 10.5 years:

1000 (1 + i / 2 ) (1 + 2i / 4 ) = 1980.
14 14

We then have
(1 + i / 2 ) = 1.98
28

(1 + i / 2 ) = (1.98) = 1.276
10 10 / 28

and the answer is

1000 (1.276 ) = $1276.

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The Theory of Interest - Solutions Manual Chapter 2

31. We are given

A (1.06 ) + B (1.08 ) = 2000
20 20

2 A (1.06 ) = B (1.08 )
10 10

which is two linear equations in two unknowns. Solving these simultaneous equations
gives:
A = 182.82 and B = 303.30 .
The answer then is
A (1.06 ) + B (1.08 ) = (182.82 )(1.06 ) + ( 303.30 )(1.08 )
5 5 5 5

= $690.30.

32. We are given that

10, 000 (1 + i )(1 + i − .05 ) = 12, 093.75.
Solving the quadratic
1 + i − .05 + i + i 2 − .05i = 1.209375
i 2 + 1.95i − .259375 = 0
−1.95 ± (1.95 ) − ( 4 )(1) ( −.259375 )
2

i=
2
= .125 rejecting the negative root.
We then have
10, 000 (1 + .125 + .09 ) = 10, 000 (1.215)
3 3

= $17,936.

33. The annual discount rate is

1000 − 920 80
d= = = .08.
1000 1000

The early payment reduces the face amount by X. We then have

X ⎡⎣1 − 12 (.08 ) ⎤⎦ = 288,
so that
288
X= = 300
.96
and the face amount has been reduced to
1000 − 300 = $700.

22