E120

Homework 2
Due 09/19/2014

1. Suppose your bank account pays interest monthly with an annual interest rate of 6%,
compounded monthly. What amount of interest will you earn each month (i.e. the
effective monthly rate)? If you have no money in the bank today, how much will you
need to save at the end of each month to accumulate $100,000 in 10 years?
2. Your firm is purchasing a new telephone system, which will last for three years. You
can purchase the system for an upfront cost of $150,000, or you can lease the system
from the manufacturer for $5000 paid at the end of each month. Your firm can borrow
at an interest rate of 6% annually with quarterly compounding.
(a) What is the effective monthly rate?
(b) Should you purchase the system outright or pay $5000 a month?
3. Which do you prefer: a bank account that pays an effective interest rate of 5% per
year (EAR) for three years or
(a) An account that pays 2.5% every six months for three years?
(b) An account that pays 7.5% every 18 months for three years?
(c) An account that pays 0.5% per month for three years?
4. Suppose the interest rate is 8% (APR) with monthly compounding. What is the present
value of an annuity that pays $100 every six months for five years (starting six months
from now)?
5. Capital One is advertising a 60-month, 5.99% APR motorcycle loan. If you need
to borrow $8000 to purchase your dream Harley Davidson, what will your monthly
payment be?
6. You have just sold your house for $1,000,000 in cash. Your mortgage was originally
a 30-year mortgage with monthly payments and an initial balance of $800,000. The
mortgage is currently exactly 18 12 years old, and you have just made a payment. If the
interest rate on the mortgage is 5.25% (APR), how much cash will you have from the
sale once you pay off the mortgage?
7. Your friend tells you he has a very simple trick for taking one-third off the time it
takes to repay your mortgage: Use your Christmas bonus to make an extra payment
on January 1 of each year (that is, pay your monthly payment due on that day twice).
If you take out your mortgage on July 1, so your first monthly payment is due August

1, and you make an extra payment every January 1, how long will it take to pay off the
mortgage? Assume that the mortgage has an original term of 30 years and an APR of
12%.
8. A loan company is offering a loan amount of L for 20 years with a quoted APR 12%
(which is used to calculate the monthly payments p). The actual APR of the loan
(after considering 3 points and loan initiation fee of $1000) is 12.65329%.
Assume that all APRs are being compounded monthly. Find L and p.
9. You took out a 30-year loan for $100,000 at an APR of 12%, compounding quarterly.
The loan officer has worked out a detail monthly payment plan for you.
(a) How much is each monthly payment?
Note: Payments start one month from the time you took out the loan.
(b) 10 years from the time you first took out the loan, you have been promoted to
CFO of your company. With extra cash in your pocket, you decided to make
extra monthly payments of $500 (in addition to what you are paying now). When
will the loan be paid off? (Non-integer solution is okay)