Question

Time Value of Money in Personal Finance

Mr. Haris, 32 years and Mrs Tini aged 30 years has been married for 5

years now. They have two kids, Arif age 4 and Amira, 1 year. The spouse

is planning to send their kids to further their study to a local university

after completing tertiary education at the age of 18. Taking into

consideration the inflation rate, education cost for the next 14 years is

estimated to be amounting RM90,000 which will include the education fee

and living expenses for a 4 years study period. This cost will increase at

the rate of 2 percent a year onwards.

The spouse has taken an insurance policy for both of the kids starting this

year. Premium payment for the policy is RM3,360 yearly for Arif and

RM3,000 yearly for Amira. This policy will give an expected return of 5.0

percent annually and will mature when the kids reach 18.

1. Calculate the value of the insurance policies for both of the children

upon maturity.

2. How much surplus or deficit the value in (1) as compared to the

cost of education for each of the children.

3. How much monthly the family should invest for each children if it is

to be invested in a unit trust fund that will give a 6 percent in return

to cover the amount in (2)?

4. If the family decide to cancel the insurance, how much lump sum

money need to be saved today to achieve the education objective

for each of the children if it to be invested in the same unit trust

fund in (3)?.

5. If the family plan to achieve the education fund in 8 year, how much

rate of return should they look for in the unit trust fund?.

(Draw the time line in all of your solution)

Answer 1

1. The value of insurance policies for both the children upon maturity is as follows:

- Mr. Arif:

Premium = RM 3,360 p.a

Compounded annually with an interest rate of 5% p.a

No. of years left for Mr. Arif to reach the age of 18 is 14 years (Policy gets matured when Arif reaches 18 years (-) Present age of Arif is 4 years). So, ,Policy tenure is 14 years.

Considering the following formula

Maturity Value = P((1+r)^n-1/r) (1+r)

Where P - Premium, r - return, n - tenure of policy

P - RM 3,360; r - 5%; n - 14 years

Maturity value = 3,360((1+0.05)^14-1/0.05)(1+0.05)

⁼ 3,360((1.05)¹³/0.05)*(1.05)

   ⁼ 3,360(37.71298)(1.05)

= 1,33,051

Maturity value of Mr.Arif policy is RM 1,33,051.

In the same way, Maturity value of Ms. Amira is as follows:

P - RM 3000, r- 5%, n - 17 years

Maturity value = 3000((1+0.05)^17-1/0.05)(1+0.05)

= 1,44,397

Maturity value of Ms. Amira policy is RM 1,44,397