SOA Exam FM Sample Question 331
Study guide: Exam FM-2
Current loan rates are based on the following term structure of interest rates:
| Investment Length (years) | Spot Rate |
|---|---|
| 1 | 5.00% |
| 2 | 5.25% |
| 3 | 5.75% |
| 4 | 6.25% |
| 5 | 7.25% |
A loan of 6000 is to be repaid with a single payment of principal plus interest at the end of five years. The borrower has two choices:
- i) a 5-year loan.
- ii) a 3-year loan to be repaid with a single payment of principal plus interest by taking out a 2-year loan at the beginning of year 4.
Calculate the annual effective interest rate on the 2-year loan such that the borrower is indifferent between the two choices.
- A) 6.25%
- B) 7.25%
- C) 8.26%
- D) 9.54%
- E) 11.00%
Answer this question and see the worked solution