Solutions Manual for

Michael M. Parmenter’s

THEORY OF INTEREST
AND LIFE CONTINGENCIES,
WITH PENSION APPLICATIONS:
A Problem-Solving Approach

Third Edition

by

Dick London, FSA

ACTEX Publications
Winsted, Connecticut
Copyright © 1999, 2010
by ACTEX Publications

No portion of this book may be reproduced in any form or by any

means without the prior written permission of the copyright owner.

Requests for permission should be addressed to

ACTEX Learning
PO Box 715
New Hartford CT 06057

ISBN: 978-1-62542-840-0
 TABLE OF CONTENTS

Chapter 1 1

Chapter 2 13

Chapter 3 18

Chapter 4 35

Chapter 5 44

Chapter 6 53

Chapter 7 60

Chapter 8 74

Chapter 9 92

Chapter 10 120

Chapter 11 135

Chapter 12 148
iv

INTRODUCTORY NOTE

This solutions manual complements a study of compound interest and

life contingencies, based on the Third Edition of Theory of Interest and
Life Contingencies, with Pension Applications: A Problem-Solving
Approach, by Michael M. Parmenter. Some of the answers in the
textbook are incorrect, and these solutions correct them. Please note that
some answers in the text differ from the answers in these solutions by
small amounts due to rounding.
 CHAPTER 1

1. (a) 14,000c16(.08)d œ 20,720.00

(b) 14,000(1.08)6 œ 22,216.24
(c) 14,000’1 365
66 (.08)“ œ 14,202.52

(d) 14,000’ 318

365 (1.08)  365 (1.08) “ œ 16,497.81
2 47 3

2. (a) 14,000(1.11)5 œ 23,590.84

(b) 14,000’15 360
96 (.11)“ œ 22,110.67

(c) 14,000’ 269

365 (1.11)  365 (1.11) “ œ 24,273.33
5 96 6

3. a(t) œ t2  t  1, and in œ 2n from part (e) of Example 1.1.

n2  n  1
2(n1)
Then in1 œ œ 2 2n  2 . Assume
(n1)2  (n1)  1 n n1
in1 in . Then 22n  2 2n ,
n n1 n2  n  1
or (2n2)(n2  n1) 2n(n2 n1), or
(2n3 2) (2n3 2n2 2n), which is clearly false for all n 1.

4. (a) a(0) œ È1  (i2 2i)0 œ 1à a(1) œ È1  i2  2i œ 1  i.

d a(t) œ 1 1  (i2 2i)t2 ‘
1  (i2 2i)t2 ‘1Î2
 1 Î2 t
(b) dt 2 † 2t œ 0

for t  0, so a(t) is increasing. Furthermore, root functions are

continuous in their domain.
(c) a(t) œ È1  (i2 2i)t2 
 1  it according as
 
1  (i2 2i)t2  1  2it  i2 t2 , or according as 2it2  2it, or
according as t 
 1. Then a(t)  1it if t  1, but a(t)  1it
if t  1.
2 Chapter 1

J(t) œ (1i)t  a(t) œ (1i)t  1(i2 2i)t2 ‘

1Î2
(d) Consider .
We find
d t 1 2 2 ‘1Î2
dt J(t) œ (1i) † ln(1i)  2 1  (i 2i)t † 2(i2 2i)t
(i2 2i)
1/t2  (i2 2i)‘1Î2
œ (1i)t † ln(1i)  .

Now as t gets larger, the negative term approaches the constant

(i2 2i)1Î2 . Since (1i)t increases, then
eventually
(1i)t † ln(1i) exceeds the negative term, so dt d J(t) is

eventually positive, so J(t) is eventually increasing, so (1i)t

eventually exceeds a(t).

a (n )
5. (a) If 1  in œ a(n  1) is constant, then

ln(1in ) œ lnca(n)d  lnca(n1)d œ J lnca(n  1)d is constant

as well. By the properties of finite differences, if Jf (n) is
constant, then f (n) itself is a linear function. Thus we find
lnca(n  1)d , and hence lnca(n)d to be a linear function, so
a(n) œ elnÒa(n)Ó is an exponential function, which can be put in
the form (1i)t .
(b) No. The argument in (a) assumed integral values of t to
establish the properties of the J operator.

6. (a) Since A(n  1) is the value of an investment at time n  1, and

A(n) is its value at time n, the difference, In , is the growth due
to interest in the nth time period.
(b) A(n)  A(0) œ c A(n)  A(n1)d  c A(n1)  A(n2)d  â
 c A(1)  A(0)d œ In  In1  â  I1 .
Chapter 1 3

(c) The result is intuitive. Clearly A(n)  A(0) is the total interest
earned over n periods, which is the sum of the interest earned in
each period.
a(1)  a(0) a(2)  a(1)
(d) i1  i2  â  in œ a(0)  a(1) â
a(n)  a(n1)
 a(n  1) Á a(n)  a(0),
so no. The ir are rates, not amounts, so they are not additive to
any meaningful concept.

(a) 1000c1.12td œ 1400, so t œ

14
1
7. 10
.12 œ 3 13 .
15
1
(b) 1000(16i) œ 1500, so i œ 6
10 œ 8 13 %.
log 1.40
(c) 1000(1.12)t œ 1400, so t œ log 1.12 œ 2.96899.

(d) 1000(1i)6 œ 1500, so i œ (1.5)1Î6  1 œ 6.9913%.

8. 1000(1it) œ 1300 implies it œ .3. Then

500’1Š 23 i‹(2t)“ œ 500’1 4
3 it“ œ 500’1Š 3 ‹(.3)“ œ 700.
4

9. 6000(1.07)4 (1.11)6 œ 14,710.40

10. (1.13)(1.11)(1.15) œ (1i)3 , so

i œ c(1.13)(1.11)(1.15)d1Î3  1 œ 12.988%.

11. We are given (1i)x œ 2, 2(1i)y œ 3, and (1i)z œ 5. In

z  x  y years, 6 will grow to
6(1i)z (6)(5)
6(1i)zxy œ œ (2)(1.5) œ 10.
(1i)x (1i)y
4 Chapter 1

12. We wish to prove that if (1i)x œ (12i)y , then x  2y for all i,

i  0. Assume x 2 y. Then (1i)x (1i)2y . But
(1i) œ (12i) , so our implication is (12i)y (1i)2y , or
x y

y(y1) 2 y(y1)(y2) 3
1  2i(y)  2 4i  6 i â
2y(2y1) 2 2y(2y1)(2y2) 3
1  2yi  2 i  6 i â

y y y2
or 2 i2 (4y  4)  6 i3 (8y2  24y16)  â 2 i (4y  2)
y
 6 i3 (8y2  12y4)  â
But (4y  4) is less than (4y  2), so we reach a contradiction,
implying x  2y. Therefore statement (a) is true.

13. (a) PV œ 1000(1  d)3 œ 681.47

(b) (1i)1 œ 1  d œ .88, so i œ (.88)1  1 œ 13.636%
(c) PV œ 1000(1i)3 œ 681.47

14. (a) PV œ 14,000(1.12)6 œ 7092.85

(b) PV œ 14,000(.88)6 œ 6501.66
(c) A rate of discount equivalent to a rate of interest is numerically
smaller than that rate of interest. If the rates are numerically the
same, then the discount is greater than the equivalent interest, so
it produces a smaller discounted value.

15. (a)

(0,1)
a(t )  1  it

(b) The present value t years in the past is (1it)1 à 1  it will

turn negative in 1i years
Chapter 1 5

a(n)  a(n1) (1i)n  (1i)n1 1 , which is

16. dn œ œ œ 1  1
a (n ) (1i)n i
constant.

17. (a) Starting with (1.16), d œ 1  i œ iŠ 1 ‹ œ iv. Verbally, the

i 1i
discount on one unit of money is the present value of the
interest on that unit.
(b) Since v œ 1  1 , then i œ 1  1, so
v
d œ iv œ Š v  1‹v œ 1  v. Verbally, the discount on one
i
1
unit is equal to the unit minus its discounted value.
(c) i  d œ i  iv œ i(1  v) œ id. Verbally, the difference
between the interest and the discount on a unit of money is the
discount on the interest itself.
(d) Since d œ 1  i , then 1 œ 1  i , and 1  1 œ i œ 1.

(e) dŠ1  2 ‹ œ d  2 œ d  2 œ 2  2 ; similarly,

i d i d i i
i id i  d i d

iŠ1  d2 ‹ œ i  id id
2 œ i  2 œ 2  2.
i d

(f) i(1  d)1/2 œ 1  d (1  d)1/2 œ d(1  d)1/2 œ d(1  i)1/2

d

d3 d 3 œ d 3 (since d œ iv) œ i2 d
18. (a) 2 œ
(1  d) v2 ( di )2
(i  d )2 (id)2
(b) 1  v œ d œ i2 d
(c) (i  d)d œ (id)d œ id 2 , which is the exception
(d) i3  i3 d œ i3 (1  d) œ i3 v œ i3 Š di ‹ œ i2 d
(e) Already is i2 d

19. d œ 1  i , and we are given i œ 216 and dL œ 200.

i, L
Substituting, we have 1  216/L † L œ 200, or L216
216 /L †L
 216 œ 200,
(200)(216)
or 216L œ 200L  (200)(216). Then L œ 16 œ 2700.
6 Chapter 1

20. We will calculate equivalent effective annual rates:

A: i œ (1.03)4  1 œ .12551
B: i œ Š1 .1197 ‹
5
5  1 œ .12557

C: i œ Š1  .118 10 ‹
10
 1 œ .12603
Thus C is the most advantageous to the investor (largest effective
annual rate), whereas A is most advantageous to Acme Trust
(smallest effective annual rate).

21. AV œ 3000(1.04)7 œ 3947.79

22. (a) (1i) œ (1.06)2 , so i œ (1.06)2  1 œ 12.36%

(b) ”1  d4 •
4
(4)
œ (1.06)2 , so

d (4) œ 41  (1.06)1Î2 ‘ œ 11.485%

(c) ”1  i12 •
12
(12)
œ (1.06)2 , so

i(12) œ 12(1.06)1Î6  1‘ œ 11.712%

(d) (1j)6 œ 1.06, so j œ (1.06)1Î6  1 œ .976%

23. (a) We are given 100(1j) œ 107, so j œ .07 effective per half-
year.
(b) i(2) œ 2j œ 14%
(c) i œ (1.07)2  1 œ 14.49%
(d) ”1  d3 • œ (1.07)2 , so
3
(3)

d (3) œ 31  (1.07)2Î3 ‘ œ 13.232%

Chapter 1 7

24. ”1  i n • œ (1i)1În œ
(n) (1i)1Î6
œ (1i)1Î24 . Therefore
(1i)1Î8
1 œ 1 , so n œ 24.
n 24

25. ”1  d7 • œ ”1 i 5 • , so d (7) œ 7”1  Š1 i 5 ‹ •

7 5 5Î7
(7) (5) (5)

vŒ1  i 3  œ (1  d)(1  i)1/3

(3)
26.
œ (1  d)1/2 (1  i)1/2 (1  i)1/3
œ (1  i)1/6 (1  d)1/2 ;

similarly,

Œ1  30 Œ1  5 (1  d) œ (1  i) (1  i) (1  d)
i(30) d (5) 1/2 1/30 1/5 1/2

œ (1  i)1/6 (1  d)1/2

27. i(4) d (8) œ 4[(1i)1/4  1] † 8[1  (1i)1/8 ]

œ 32[(1i)1/4  (1i)1/8  (1i)1/8  1]
œ 32[(1i)1/8 [1  (1i)1/8  (1i)2/8  (1i)3/8 ]

i(8) d (4) œ 8[(1i)1/8  1] † 4[1  (1i)1/4 ]

œ 32[(1i)1/8  (1i)1/8  (1i)1/4  1]
œ 32[(1i)2/8 [1  (1i)1/8  (1i)2/8  (1i)3/8 ]

(4) (8) (1i)1/8

Then i(8) d (4) œ œ (1i)1/8 1, so i(4) d (8) i(8) d (4) , as
i d (1i)2/8
required.
8 Chapter 1

28. (a) From (1.21), we have Œ1  dm  œ Œ1  im  .

1
(m) (m)

d (m) œ m–1  Œ1  im  —
1
(m)
Then

œ m  mŒ m

m  i(m)
2 (m) 2 (m)
œ m  m † i (m) m œ m † i (m) .
mi mi

This leads to m † d (m)  i(m) d (m) œ m † i(m) , and then to

(m) (m)
i(m)  d (m) œ i m d , as required.
(m)
(b) 1(m)  (1m) œ i (m d (m) œ 1 , as required, using the result
d i i d) (m) m
from part (a).

29. Recall that e$ œ 1  i, so $ œ ln(1i).

(a) $ œ ln(1.13) œ .12221
(b) $ œ ln(1  .13)1 ‘ œ .13926

(c) $ œ ln”Š1 .13

4 ‹ • œ .12793
4

(d) $ œ ln”Š1  .13

5 ‹ • œ .13171
5

d ? œ i  (1i)t † ln(1i). ?
30. Let ?t œ 1  it  (1i)t , so that dt t t
d
is maximized at the value of t for which dt ?t œ 0. Thus we have

i  (1i)t † ln(1i) œ i  $ (1i)t œ 0,

or i œ $ (1i)t . Then

ln i œ ln $  t † ln (1i) œ ln $  t † $ .

Finally we have t œ 1 [ln i  ln $ ], as required.

$
Chapter 1 9

2 3
31. (a) Recall that i œ e$  1 œ $  $2!  $3!  â. If $ is doubled,
then we have

$ 2  8$ 3  â
iw œ e2$  1 œ 2$  42! 3!

œ 2”$  $2!  $3!  â•  ” 22! •

2 3
$ 2  6$ 3  â
3!

œ 2i  positive terms,

so iw  2i.

(b) Recall that 1  d œ (1i)1 œ e$ , so

d œ 1  e$ œ 1  ”1  $  $2!  $3!  â•

2 3

2 3
œ $  $2!  $3!  âÞ

If $ is doubled, then we have

$ 2  8$ 3  â
d w œ 1  e2$ œ 2$  42! 3!

œ 2”$  $2!  $3!  â•  ” 22! •

2 3
$ 2  6$ 3  â
3!

œ 2d  net negative terms,

so d w  2d.

2 3
32. From Exercise 31(a), i  $ œ $2!  $3!  â so
i  $ œ 1  $  $ 2  â. As i Ä 0, $ Ä 0 as well, so
$2 2! 3! 4!
lim i 2 $ œ 2!
1 œ .50, as required.
iÄ0 $
10 Chapter 1

a(t) œ exp”( $r dr• œ exp”( 1  r dr•

t t
33. .04

œ exp.04 † ln(1r)kt0 ‘
0 0

œ exp’ln(1r).04 ¸0 “
t

.04
ln(1).04
œ eln(1t) œ (1t).04

d cln A(t)d
d
dtA (t)
34. $t œ œ dt
A (t )
d ln k  (t1) ln a  t3 ln b  d t ln c‘
œ dt
œ ln a  3t2 ln b  d t ln d ln c

35. At n œ 1 we have dvd ($ ) œ d (ln v) œ  1 œ (1i), which

dv v
is (1i)(n1)x, since 0x œ 1. Now we hypothesize that
d n Šv n1 $) œ (1i)(n  1)x, and show that this implies
dv n
d n1 (v n $ ) œ (1i)nx.
dv n1

d n1 cv n $ d œ d n ’ d (v n $ )“ œ d n v n † (1i)  $ † n † v n1 ‘

dv n1 dv n dv dv n
ðóóñóóò ðóóóóóñóóóóóò
n n
œ  d n v n1  n † d n (v n1 $ )
dv dv
0 (1i)(n  1)x
œ (1i)nx q.e.d.

2 3 4
36. e$ œ 1i, so v œ (1i)1 œ e$ œ 1  $  $  $  $  â
2x 3x 4x

d œ 1  (1i)1 œ 1  1i  i2 i3  â‘ œ i  i2  i3  i4  â

37. 1  d œ (1i)1 , so
Chapter 1 11

38. i(n) œ n(1i)1În  1‘ œ n’1  1

n i  Š n ‹Š n  1‹ 2 i  â“
1 1 1 2

œ i  Š1
n  1‹ 2 i  â
1 2

Similarly, i(m) œ i  Š m1 1‹ 1 i2  â . If n  m, then 1  1 , so

n m
Š n  1‹  Š m  1‹, and i(n)  i(m) . The result is also intuitive.
2
1 1
If n  m there is more compounding each year, so i(n) can be less
than i(m) and still achieve the same accumulation.

39. d (n) œ n1  (1d)1În ‘

œ n’1  Š1  1 n d  Š n ‹Š n 1‹2 d  â‹“
1 1 1 2

œ d  Š1n 1‹d â
2

With n  1, then 1 n  1, so Š n  1‹  0, so Š n  1‹d  0, so

1 1 2

d (n)  d. Thus we see d (m)  d (n) for n  m, and $ œ d (_)  d (n) ,

since _  n. Therefore d  d (n)  $ . Similarly, but in the other
direction, i(n)  i(m) if n  m, from Exercise 1-38. Therefore
$ œ i(_)  i(n)  i(1) œ i, since _  n  1.

Dc A(t)d
40. Recall from (1.30) that $t œ A(t) . Then
Dc A(t)d A(t) † D2 c A(t)d  Dc A(t)d † Dc A(t)d
D($t ) œ D” •œ
A (t) c A (t)d2

D c A (t ) d ŠDc A(t)d‹
2
2

c A (t) d 2
œ A (t) 
D2 c A(t)d 2
œ A(t)  ($t ) . q.e.d.
12 Chapter 1

2 3 4
41. From (1.33) we have $ œ i  i2  i3  i4  â . From
2 3 4
$ œ ln v œ ln(1  d)1 , we have $ œ d  d2  d3  d4  â .
Adding we obtain 2$ œ (di)  Š d2  i2 ‹  Š d3  i3 ‹  â,
2 2 3 3

so $ œ d i d 2  i2 d 3 i3
2  4  6  â . q.e.d.

2 3
42. Since, from (1.34), i œ $  $  $  â, then
2x 3x
2 3 4
i$ œ $ $ $
   â . Similarly,
2x 3x 4x
$  d œ $  ”$  $  $  $  â• œ $  $  $  â ,
2 3 4 2 3 4
2x 3x 4x 2x 3x 4x
so clearly i  $ is larger.