ACST202/ACST851 : Maths of Finance

Tutorial Solutions 5 : Varying Annuities

Question 1
A pdf file containing sample values was provided in the previous topic.
Question 2
Multiple solutions are given for some parts.
(a) $200s10 + $50 ( Is )10 at 8% $250s10 + $50 ( Is )9 at 8%

$1, 425aɺɺ20 − $25 ( Iaɺɺ)20 at 1.08 2 − 1 $1, 400aɺɺ20 − $25 ( Ia )19 at 1.08 2 − 1
1 1
(b)

(c) $1, 260a40 + $40 ( Ia )40 at 1.013 − 1 $1,300a40 + $40v ( Ia )39 at 1.013 − 1

(d) {$191a 11
+ $9 ( Ia )11 } (1 + i ) at 1.042 − 1
5
{$191aɺɺ 11
+ $9 ( Iaɺɺ)11 } (1 + i ) at 1.042 − 1
4

{$200a 11
+ $9v ( Ia )10 } (1 + i ) at 1.042 − 1
5

{$191s 11
+ $9 ( Is )11 } v 6 at 1.042 − 1

{$200s 11
+ $9 ( Is )10 } v 6 at 1.042 − 1

(e) {$24, 000a 8

+ $4, 000 ( Ia )8 }
i
i
( 4)
at 8%

{$28, 000a 8
+ $4, 000v ( Ia )7 }
i
i
( 4)
at 8%

(f) $205a10 − $5 ( I a )10 at 8% $200a10 − $5v ( I a )9 at 8%

(g) $95s20 + $5 ( I s ) 20 at 1.022 − 1 $100 s20 + $5 ( I s )19 at 1.022 − 1

(h) {
$20 ( I a )6 8% + 1.08−6 $120a4 9% + $20 ( I a )4 9% }
$20 ( I a )6 8% + 1.08−6 {$140a 4 9%
+ $20 × 1.09−1 × ( I a )3 9% }
(i) $20 ( I s )6 8% × 1.094 + $120 s4 9% + $20 ( I s )4 9%

(j) $100 ( I a )4 + $400v 4 a6 + $150v 4 ( I a )6 at 8%

$100 ( I a )10 + $50v 4 ( I a )6 at 8%

(k) $1, 000a10 + $100 ( I a )10 at 1.042 − 1

$500a20 + $25 ( I a )20 at 4% . The rate of payment starts at $500 per half year and ends at
$1000 per half year. The increase is $500 per half year. This increase occurs over 20 half
$500
per ( half-year ) .
2
years, so the rate of increase is
20

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Question 3
$100 + $5t 0 ≤ t ≤ 20
The rate of payment at time t is 
 $200 20 ≤ t ≤ 30
There are two simple ways to subdivide the payments into 3 sections.

$200
Present value
= $100a20 + $5 ( I a ) 20 + $200v 20 a10 at 8%
$100
= $100 ×10.205836 + $5 × 76.855407 + $200v 20 × 6.975042
= $1704.16
20 30

$200
Present value
= $100a30 + $5 ( I a )20 + $100v 20 a10 at 8%
$100
= $100 ×11.702319 + $5 × 76.855407 + $100v 20 × 6.975042
= $1704.16
20 30

These solutions are more efficient than solutions like $100a30 + $5 ( I a )30 − $5v 20 ( I a )10 since that
requires us to evaluate 2 increasing annuities, which are more time consuming to evaluate by
calculator than are level annuities.
Question 4
Since the increases occur quarterly, we will work in quarters throughout.
1
The effective quarterly interest rate is 1.05 2 − 1 = 2.4695%
In the first quarter, payments are at the rate of $0.25 per quarter.
Accumulation
= 1
4 ( I s )40 at 2.4695%
s40 − 40
ɺɺ
= 1
at 2.4695%
4
δ
68.60177 − 40
= 1
4
log1.024695
= $293.11
Alternative method
1
12 {s 3
at 0.81648%}{( Is )40 at 2.4695%} = 121 × 3.0368873 × 1158.2008 = $293.11

This is less efficient since it also requires calculation of the effective monthly interest rate.
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Question 5
(a) The effective annual interest rate is 10.25%. Payments start at the rate of zero and increase to
$1,000 per annum over 10 years. That is, at the end of the first year payments are at the rate of
$100 per annum.
$100 ( I a )10 at 10.25% = $100 × 26.816074 = $2,68161
.

(b) The interest rate is 5% per half year. Payments start at the rate of zero and end at the rate of
$500 per half year after 20 half years. That is, at the end of the first half-year payments are at
20 = $25 per half year.
the rate of $500

$25 ( I a )20 at 5% = $25 × 107.264297 = $2,68161

.

Question 6
Value at 1/1/2000
 1 1.06 1.067 
= $150  5
+ 6
+ ... +  ( 8 terms )
1.07 1.07 1.0712 
1.067 × 1.09 1.067 × 1.092 1.067 × 1.0912 
+$150  13
+ + ... +  (12 terms )
 1.07 1.0714 1.07 24 
$150 1 − ( 1.06
1.07 ) $150 ×1.067 ×1.09 1 − ( 1.09
1.07 )
8 12

= +
1.07 1 − 1.07
5 1.06
1.0713
1 − 1.0
1.09
7

$150 1 − ( 1.07 ) + $150 ×1.067 ×1.09 1 − ( 1.07 )

1.06 8 1.09 12

=
1.07 1.07 − 1.06
4
1.0712
1.07 − 1.09
= $828.1141 + $1358.2290
= $2,186.34
Question 7
(a) Required value

= $0.47 (1 + i ) 12 a∞ at 12%
5

5 1
= $0.47 × 1.1212 ×
0.12
= $4.11
Alternatively, required value
= $0.47v 12 aɺɺ∞ at 12%
7

1.12 1+ i
aɺɺ∞ = (1 + i ) a∞ =
− 12
7
= $0.47 × 1.12 ×
0.12 i
5 1
= $0.47 × 1.1212 ×
0.12
as before.

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(b) We revert to summing the payments from first principles.
Required value

{
= $0.47 1.1v 12 + 1.12 v 12 + 1.13 v
7 17 7
2 12
}
+ ... at 12%
−7
1.1× 1.12 12
= $0.47 ×
1.1
1−
1.12
1.1× 1.12 12
5

= $0.47 ×
1.12 − 1.1
= $27.10
(c) Required value

{
= $0.47 1.11v 12 + 1.112 v 12 + 1.113 v
7 17 7
2 12
}
+ ... at 12%
− 12
1.11× 1.12
7

= $0.47 ×
1.11
1−
1.12
1.11× 1.12 12
5

= $0.47 ×
1.12 − 1.11
= $54.69

Question 8
aɺɺ14 − 14v14
(a) ( Ia )14 = = 44.16719
i
aɺɺ20 − 20v 20
(b) ( I a )20 = = 55.52382
δ
a25 − 25v 25
(c) (I a ) 25
=
δ
= 110.12088

s7 − 7
ɺɺ
(d) ( Is )7 = = 35.83078
i
s6 − 6
ɺɺ
(e) ( I s )6 = = 23.40651
δ
s14 − 14
(f) (I s ) 14
=
δ
= 113.04097

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 Additional Exercise Solutions 5
Question 1
(a) We can build up ( I a )n and ( I s ) n by summing a series of level continuous annuities.

0 1 2 .. . n-2 n-1 n

( I a )n ( I s )n

( I s )n = s1 + s2 + s3 + ... + sn

(1 + i ) −1 (1 + i ) −1 (1 + i ) −1 (1 + i ) −1
1 2 3 n

= + + + ... +
δ δ δ δ
sn − n
ɺɺ
=
δ
While we could sum (1 + i ) + (1 + i ) + (1 + i ) + ... + (1 + i ) as a geometric progression, you
1 2 3 n

should be able to recognise it as ɺsɺn , with the terms just written in the opposite order to what
we are used to.
If you want to try the same sort of trick for the present value annuity, the first line should be
( I a )n = an + v an −1 + v 2 an −2 + ⋯ + v n −1a1

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(b)
( Is )n = s1 + s2 + s3 + ... + sn

(1 + i ) −1 (1 + i ) −1 (1 + i ) −1 (1 + i ) −1
1 2 3 n

= + + + ... +
i i i i
sn − n
ɺɺ
=
i
(c)
n

t + ∆t
t

0 t n

(I a ) n
(I s) n

The lightly shaded triangle shows the payments we want to value. We slice it up into a series
of horizontal strips of height ∆t . For convenience, define the set of the starting points of these
strips to be A = {0, ∆t ,2 ∆t ,..., n − ∆t} .

In the diagram, we show the strip which runs from t to t + ∆t along the vertical axis. It
involves payments at the rate of ∆t per time period for n − t time periods, giving a value at
time n of sn −t ∆t .

Letting ∆t → 0 , the series of rectangles will fill in the triangle, so

(1 + i )
n −t
n n
−1 sn − n
( I s )n = lim ∑ sn−t ∆t = ∫ sn−t dt = ∫
∆t → 0 δ
dt =
δ
t∈A 0 0

n
( n −t )
The last step involves recognising that ∫ (1 + i )
0
dt = sn

This method is conceptually challenging, but if you can cope with the challenge, the
subsequent algebra is surprisingly easy. It even avoids the need for integration by parts, which
we needed in the lectures to derive the formula for the corresponding a-type annuity, ( I a )n .

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Question 2
(a)

( Is ) n = (1 + i ) + 2 (1 + i ) + ... + ( n − 1)(1 + i )
n −1 n−2
+n
1

(1 + i ) × ( Is ) n = (1 + i ) + 2 (1 + i ) + 3 (1 + i ) + ... + n (1 + i )
n n −1 n−2 1
So

Subtracting the first equation from the second gives:

i × ( Is )n = (1 + i ) + (1 + i ) + (1 + i ) + ... + (1 + i ) − n
n n −1 n−2 1

sn − n
ɺɺ
( Is )n =
i
(b) Using the appropriate factor to adjust payments from annually in arrears to continuously over
each year gives
i sn − n
ɺɺ i sn − n
ɺɺ
( I s )n = ( Is )n × = × =
δ i δ δ
(c) If you want the whole derivation using integration by parts, here it is.
n

(I s ) n
= ∫ t (1 + i )
n −t
dt
0
n
= ∫ t eδ ( n −t ) dt
0

( )
n
= ∫t d
dt
−1
δ eδ ( n −t ) dt
0
n
=  −δt eδ ( n −t )  − ∫ −δ1 eδ ( n −t ) dt
n

0
0
n
= ( −δn − 0 ) + δ1 ∫ (1 + i )
n −t
dt
0

sn − n
=
δ
However, we can simplify the above method by factoring out the (1 + i ) term giving
n

n n

( I s )n = ∫ t (1 + i ) n −t
dt = (1 + i )
n
∫ te
−δ t
dt
0 0

The integral is then exactly what we had in lectures when we derived the formula for ( I a ) n ,
so we get the result
an − nv n sn − n
(1 + i ) ( I a )n = (1 + i ) =
n n

δ δ

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Question 3
δ = 5% ⇒ i = 5.12711%
Present value in dollars
= 4a4 + 3 ( I a )4 at 5.12711%
= 4 × 3.625 385 + 3 × 7.009 239
= 35.5293
The present value is $35.53, which matches the answer given in the earlier topic. If you wish, you
can also verify that this annuity expression matches the final line before the evaluation in the earlier
solution.
1 − e −4δ
−4δ − 4e −4δ
1− e δ
4a4 + 3 ( I a )4 = 4 × + 3×
δ δ
−4δ − 4δ
4 16e 1− e
= − + 3×
δ δ δ2
4 16e−4×0.05 1 − e −4×0.05
= − + 3×
0.05 0.05 0.052
= 80 − 320e−0.2 + 1200 × (1 − e −0.2 )
= 1280 − 1520e −0.2
This matches the earlier solution.
Question 4
If the values of the 2 streams are equal at 19/5/1997 at 8%, they will also be equal to each other at
8% at any other date we choose. For convenience, we will use a calculation date of 1/1/2000.
Equating the values of the 2 annuities at 1/1/2000 we have
xs9 + 200 ( Is )8 = 3000a10 − 150 ( I a )10 at 8%
s8 − 8
ɺɺ a10 − 10v10
xs9 + 200= 3000a10 − 150
i δ
12.487557 x + 200 × 43.594471 = 3000 × 6.975042 − 150 × 30.445369
12.487557 x + 8, 718.89 = 16,358.32
x = 611.76
An alternative expression for the left hand side is ( x − 200 ) s9 + 200 ( Is )9

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Question 5
We shall work in half years throughout.

1% per month 2.5% per quarter

250 255 320

... ...

1/1/05 1/1/08 1/1/15 1/7/37

1 15 60

1% per month = 6.15202% per half year. 2.5% per quarter = 5.0625% per half year.
Let i = 6.15202% and let j = 5.0625%
Value the annuity in two bits: the first 15 payments (up to and including the 1/1/15 payment) and
the remaining 45 payments.
Required value

{ } {
= $245a15i + $5 ( Ia )15 1.01−30 + $320a45j + $5 ( Ia ) 45 1.01−120
i j
}
= {$245 × 9.616502 + $5 × 66.356208}1.01−30 + {$320 × 17.612725 + $5 × 269.202150}1.01−120
= $2, 687.8240 × 1.01−30 + $6,982.0827 × 1.01−120
= $1,994.1582 + $2,115.5346
= $4,109.69
Question 6
(a) The infinite series in question is:
1v + 2v 2 + 3v3 + ... + nv n + ...

If we let an denote the nth term of the series, then the ratio test for convergence gives:

lim
an +1
= lim
( n + 1) v n +1
= lim
(1 + 1n ) = 1 < 1 for any positive interest rate.
n →∞ a n →∞ nv n n →∞ 1 + i 1+ i
n

Hence the series converges and the symbol should make sense.

1
(b) From the previous topic where we considered perpetuities we know lim aɺɺn = .
n →∞ d
Using l’hôpital’s rule, we have
n 1
lim nv n = lim = lim =0
(1 + i ) δ (1 + i )
n →∞ n →∞ n n →∞ n

and so:
aɺɺn − nv n
−0 1 1
lim ( Ia )n = lim = = d
n →∞ n →∞i i id
1+ i
Since d = iv , an alternative answer is 2 .
i

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Question 7

500
500

500
400
400

400
300
300

300
200
200

200
100
100

100
... ... ... ... ...
0 1 2 3 4 5
If the payments within each year had all been made at the end of that year, the accumulation would
i
be $1200 ( Is )5 at 8%. To adjust this to monthly in arrears, multiply by (12 ) at 8%.
i

Accumulation
i
= $1200 ( Is )5 at 8%
(12)
i s5 8% = 6.335929
ɺɺ
s −5 i
ɺɺ
= $1200 5 × (12) at 8%
 i (12 ) 
12
i i
1.08 =  1 +  ⇒ i = 7.7208%.
(12)
s −5
ɺɺ 12
= $1200 5 (12) at 8%  
i
= $20, 763.49

Question 8
(a) Present value

( 1.06 ) − 1 = $2, 385.17

10 10 1.05 10
$250  1.05 t 10
= ∫ $250 × 1.05 × 1.06 dt = $250 ∫ (
t −t
)
1.05 t
dt = ( ) = $250
ln ( 1.06 )
1.05  1.06  0
ln ( 1.06 )
1.06 1.05
0 0

(b) Present value

10 10
= ∫ $250 × 1.05 × 1.05 dt = $250 ∫ 1 dt = $250 [t ]0 = $2, 500
−t
t 10

0 0

Check that the answer to (a) is less than (b) due to discounting at a higher interest rate.

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Question 9
Firstly we’ll get an intermediate result required for the differentiation.
di
Since v = (1 + i ) we have i = v −1 − 1 and = −v −2 = − (1 + i )
−1 2

dv
dv di
Alternatively v = (1 + i ) gives = − (1 + i ) which also gives = − (1 + i )
−1 −2 2

di dv
Now
d 1 − vn
d
dv
{v + v 2
+ v 3
+ ... + v n
} dv i
=

1 + 2v + 3v + ... + nv
2 n −1
=
{
i ( −nv n −1 ) − (1 − v n ) − (1 + i )
2
}
2
i
1− v n
(1 + i ) − nv n −1
2

( Iaɺɺ) n = i
i
an (1 + i ) − nv n
=
iv
aɺɺn − nv n
=
d
This solution looks rather short for a question labelled as an extreme algebra challenge. The catch is
that the most efficient order to do things is not obvious, so your first attempt is likely to be much
longer. So don’t panic if you didn’t produce this short a solution on your first attempt. Neither did
we.

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