102 Session 3

annuities certain

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Faculty & Institute of Actuaries & are used
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Jargon: What is “v” short for?

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 What is v short for?
V is “present” value of a payment of 1 in a
year’s time.

E.g. if i = 5% and payment is £1 in a year,

value is £1 * v = £1 / 1.05 = £0.9524.

(You need to set aside 95.24p to be able

to pay £1 in a year)

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 Deduce a4¬ formula
Goal: show that a4¬ = (1 – v^4) / i

Let X = a4¬ ie X is amount needed to invest now, in order to pay 1

at end of each of next 4 years

amount 1 1 1 1

Time 1 2 3 4

Value (X) = 1v + 1v^2 + 1v^3 + 1v^4

(1+i)(X) = 1+ 1v + 1v^2 + 1v^3

Subtracting,
(i)(X) = (1 – 1v^4)
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Sep 2000 Q13(i)a

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 Sep 2000 Q13(i)a

1 2 3 4 5
100
Present value

= 100k * a…. ¬

= 100k * (1 – v^….) / …

= 100k * (1 – …….) / …
0

100v + 100v^2 + 100v^3 + 100v^4 + 100v^5 = 100k * …………

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 Sep 2000 Q13(i)a

1 2 3 4 5
100
Present value

= 100k * a5 ¬

= 100k * (1 – v^5) / i

= 100k * (1 – 1.05^-5) / 0.05

0

100v + 100v^2 + 100v^3 + 100v^4 + 100v^5 = 100k * 4.32948

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Sep 2000 Q13(i)a

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 Sep 2001 Q10(i)

Yield is ………… than coupon so part of the

yield comes from ………… gain.
105 Ie purchase price per 100 nominal < …...
100 If yield were 5%, price would be ……..
By rule of thumb, payments are made at about 2/3
of term of bond (about 13 years),
so rise in yield of 1%, drops value by about …. * 1%.
So expect price about 100 – ….. = 87.

Exact purchase price per 100 nominal

= value discounted at gross redemption yield
5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5
= …. (v + v^2 + … + v^20) + ….v^20
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 = …. a…. ¬ + ….v^20
= …………………………………………
= ………………………………………….
= ………………………….. (OK cf estimate?)

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 Sep 2001 Q10(i)

Yield is higher than coupon so part of the

yield comes from capital gain.
105 Ie purchase price per 100 nominal < 100
100 If yield were 5%, price would be 100
By rule of thumb, payments are made at about 2/3
of term of bond (about 13 years),
so rise in yield of 1%, drops value by about 13 * 1%.
So expect price about 100 – 13 = 87.

Exact purchase price per 100 nominal

= value discounted at gross redemption yield
5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5
= 5 (v + v^2 + … + v^20) + 100v^20
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 = 5 a20 ¬ + 100v^20
= 5 (1 – v^20)/i + 100v^20
= 5 * (1 – 1.06^-20) / 0.06 + 100 * 1.06^-20
= 5 * 11.4699 + 100 * 0.31180 = 88.53 (OK cf estimate)

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Sep 2001 Q10(i)

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 Sep 2003 Q7(i)

1 2 3 4 … … … 297 298 299 300

300 equal payments of say £m will be made at times 1, 2, 3, …, 299, 300.

Very roughly, payments are made on average at ….. years. So total payment will be
about 100000 * 1.05^…… = ……… & monthly payment will be ……… / 300 = …..

Work in months as the unit of time.

Effective monthly rate of interest = ……^(1/12) – 1 = ……….%

100,000 = Value of loan investment = value of cashflows from loan

= m v + m v^2 + .. + m v^300 = m a300¬ discounted at ………..%

= m * …………………
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Therefore monthly payment = 100,000 / …………… = £………. pcm
 Sep 2003 Q7(i)

1 2 3 4 … … … 297 298 299 300

300 equal payments of say £m will be made at times 1, 2, 3, …, 299, 300.

Very roughly, payments are made on average at 12.5 years. So total payment will be
about 100000 * 1.05^12.5 = 184,000 & monthly payment will be 184000 / 300 = £610.

Work in months as the unit of time.

Effective monthly rate of interest = 1.05^(1/12) – 1 = 0.4074%

100,000 = Value of loan investment = value of cashflows from loan

= m v + m v^2 + …+ m v^300 = m a300¬ discounted at 0.4074%

= m * (1.004074^-300) / 0.4074% = m * 172.969.

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Therefore exact monthly payment = 100,000 / 172.969 = £578.14
Sep 2003 Q7(i)

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 Specimen 1

Jargon

S means “accumulated amount” of an annuity of payable each period

The (4) means ¼ ie 0.25 is paid 4 times per period
The umlaut(?) means that the 0.25 is paid at the start of each ¼ period.

0 0.25 0.5 0.75 … … … 19 19.25 19.5 19.75 20

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 Specimen 1

S means “accumulated amount” of an annuity of payable each period

So s = (1 + i)^20 * a

The (4) means ¼ ie 0.25 is paid 4 times per period

So a(4) 20¬ = 0.25 * a(4 * 20)¬ at interest rate applicable over the quarter.

The umlaut(?) means that the 0.25 is paid at the start of each ¼ period
So a (due) = (1 + interest rate over the period) * a (in arrears)

0 0.25 0.5 0.75 … … … 19 19.25 19.5 19.75 20

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 Specimen 1

s = (1 + …… )^20 * a

Interest applicable over the period = ……. ^(1/4) – 1 = ……

So a(4) 20¬ @ 7.5% = 0.25 * a(4 * 20)¬ @ ….. =
So a (due) = (1 + ……) * a (in arrears)

Hence required accumulated annuity = …… * ……….. * ……… = …..

0 0.25 0.5 0.75 … … … 19 19.25 19.5 19.75 20

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 Specimen 1

s = (1 + 7.5% )^20 * a = 4.2479 * a

Interest applicable over the period = 1.075 ^(1/4) – 1 = 1.8245%

So a(4) 20¬ @ 7.5% = 0.25 * a(4 * 20)¬ @ 1.8245% = 10.4769
So a (due) = (1 + 1.8245%) * a (in arrears)

Hence accumulated annuity = 4.2479* 1.018245 * 10.4769 = 45.316

(Cf 20 cash paid with about 10 years interest = 20 * 1.075^10 = 41)

0 0.25 0.5 0.75 … … … 19 19.25 19.5 19.75 20

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Specimen 1

100
 Sep 2001 5

Price > 100 since Still to come: …. more coupon payments

coupon > yield
Plus … redemption payment

Half yearly interest rate = …..^0.5 – 1 = ……%

Value now Value / 100 nominal =
{ …. * a14 + … v^14 @ ….% } discounted for …. days
= { …………………………………} * …….^-(8/365)
= ……….

-8 days 0.5 1.5 2.5 3.5 4.5 5.5 6.5

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 Sep 2001 5

Price > 100 since Still to come: 14 more coupon payments

coupon > yield
Plus 1 redemption payment

Half yearly interest rate = 1.06^0.5 – 1 = 2.9563%

Value now Value / 100 nominal =
{ 4 * a14 + 100 v^14 @ 2.9563% } discounted for 8 days
= { 4 * 11.3298 + 100 * 0.6651 } * 1.06^-(8/365)
= 111.68

-8 days 0.5 1.5 2.5 3.5 4.5 5.5 6.5

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Sep 2001 5

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 Next session:
increasing & decreasing
annuities

END
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