SYLLABUS OF BASIC EDUCATION

2019
Financial Mathematics – Exam 2

The syllabus for this basic education requirement is defined in the form of learning objectives that set forth,
usually in broad terms, what the candidate should be able to do in actual practice.

Please check the “Syllabus Updates” section of the CAS Web Site for any changes to the Syllabus. The
options for obtaining credit for this basic education requirement are listed below and in Examination Rules, C.
Grades and Accreditation, Waivers of Examinations section of the Syllabus.

The purpose of the syllabus is to develop knowledge of the fundamental concepts of financial mathematics,
and how those concepts are applied in calculating present and accumulated values for various streams of
cash flows as a basis for future use in: reserving, valuation, pricing, asset/liability management, investment
income, capital budgeting, and valuing contingent cash flows. The candidate will also be introduced to
financial instruments, including derivatives, and the concept of no-arbitrage as it relates to financial
mathematics.

A basic knowledge of calculus and an introductory knowledge of probability is assumed.

A. Interest Theory
LEARNING OBJECTIVES

1. For time value of money, define and recognize the definitions of the following terms:
• Interest rate (rate of interest)
• Simple interest
• Compound interest
• Accumulation function
• Future value
• Present value/net present value
• Discount factor
• Discount rate (rate of discount)
• Convertible m-thly
• Nominal rate
• Effective rate
• Inflation and real rate of interest
• Force of interest
• Equation of value

Materials for Study, 2019 Exam 2 Exam 2-1

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SYLLABUS OF BASIC EDUCATION
2019
Financial Mathematics – Exam 2

LEARNING OBJECTIVES

2. For time value of money, the candidate will be able to do the following:
• Given any two of interest rate, present value, or future value, calculate the third based on simple or
compound interest.
• Given any one of the effective interest rate, the nominal interest rate convertible m-thly, the effective
discount rate, the nominal discount rate convertible m-thly, or the force of interest, calculate all of the
other items.
• Write the equation of value given a set of cash flows and an interest rate.
3. For annuities with payments that are not contingent, define and recognize the definitions of the following
terms:
• Annuity-immediate
• Annuity-due
• Perpetuity
• Payable m-thly, or Payable continuously
• Level payment annuity
• Arithmetic increasing/decreasing payment annuity
• Geometric increasing/decreasing payment annuity
• Term of annuity
4. For annuities with payments that are not contingent, the candidate will be able to do the following:
• Given an annuity with level payments, immediate (or due), payable m-thly, (or payable
continuously), and any three of present value, future value, interest rate, payment, and term calculate
the remaining two items.
• Given an annuity with non-level payments, immediate (or due), payable m-thly, (or payable
continuously), the pattern of payment amounts, and any three of present value, future value, interest
rate, payment amounts, and term of annuity calculate the remaining two items.
5. For loans, define and recognize the definitions of the following terms:
• Principal
• Interest
• Term of loan
• Outstanding balance
• Final payment (drop payment, balloon payment)
• Amortization
• Sinking fund
6. For loans, the candidate will be able to do the following:
• Given any four of term of loan, interest rate, payment amount, payment period, principal, calculate
the remaining items.
• Calculate the outstanding balance at any point in time.
• Calculate the amount of interest and principal repayment in a given payment.
• Given the quantities, except one, in a sinking fund arrangement calculate the missing quantity.

Materials for Study, 2019 Exam 2 Exam 2-2


SYLLABUS OF BASIC EDUCATION
2019
Financial Mathematics – Exam 2

LEARNING OBJECTIVES

7. For bonds, define and recognize the definitions of the following terms:
• Price
• Redemption value
• Par Value/Face value
• Coupon, Coupon rate
• Term of bond
• Yield rate
• Callable/non-callable
• Book value
• Accumulation of discount/Amortization of premium
8. For bonds, the candidate will be able to do the following:
• Given any four of price, redemption value, yield rate, coupon rate, and term of bond, calculate the
remaining item.
9. For general cash flows and portfolios, define and recognize the definitions of the following terms:
• Yield rate/rate of return
• Dollar-weighted rate of return/Time-weighted rate of return
• Current value
• Duration (Macaulay, modified and effective)
• Convexity
• Portfolio and investment year allocation methods
• Spot rate
• Forward rate
• Yield curve
• Stock price, stock dividend
10. For general cash flows and portfolios, the candidate will be able to do the following:
• Calculate the current value of a set of cash flows.
• Calculate the portfolio yield rate.
• Calculate the dollar-weighted and time-weighted rate of return.
• Calculate the duration and convexity of a set of cash flows.
• Calculate either Macaulay or modified duration given the other.
• Use duration and convexity to approximate the change in present value due to a change in interest
rate.
• Calculate the price of a stock using the dividend discount model.
11. For immunization, define and recognize the definitions of the following terms:
• Cash-flow matching
• Immunization (including full immunization)
• Redington immunization

Materials for Study, 2019 Exam 2 Exam 2-3


SYLLABUS OF BASIC EDUCATION
2019
Financial Mathematics – Exam 2

LEARNING OBJECTIVES

12. For immunization, the candidate will be able to do the following:

• Construct an investment portfolio to fully immunize a set of liability cash flows.
• Construct an investment portfolio to match present value and duration of a set of liability cash flows.
• Construct an investment portfolio to exactly match a set of liability cash flows.

B. Financial Economics
LEARNING OBJECTIVES

1. For general derivatives, define and recognize the definitions of the following terms:
• Derivative, Underlying asset, Over-the-counter market
• Ask price, Bid price, Bid-ask spread
• Short selling, Short position, Long position
• Stock index
• Spot price
• Net profit/payoff
• Credit risk
• Marking-to-market
• Margin, Maintenance margin, Margin call
2. For general derivatives, evaluate an investor's margin position based on changes in asset values.
3. For options, define and recognize the definitions of the following terms:
• Call option, Put option
• Expiration, Expiration date
• Strike price/Exercise price
• European option, American option, Bermudan option
• In-the-money, At-the-money, Out-of-the-money
• Covered call, Naked writing
• Dividends
• Put-call parity
4. For options, evaluate the payoff and profit of basic derivative contracts.

Materials for Study, 2019 Exam 2 Exam 2-4


SYLLABUS OF BASIC EDUCATION
2019
Financial Mathematics – Exam 2

LEARNING OBJECTIVES

5. For hedging and investment strategies, define and recognize the definitions of the following terms:
• Hedging, Arbitrage
• Diversifiable risk, Nondiversifiable risk
• Synthetic forwards
• Spreads (including bull, bear, box, and ratio spreads)
• Collars (including zero-cost collars), Paylater strategy
• Straddles (including strangles, written straddles and butterfly spreads)
• Convertible bond, Mandatorily convertible bond
6. For hedging and investment strategies, the candidate will be able to:
• Explain how derivative securities can be used as tools to manage financial risk.
• Explain the reasons to hedge and not to hedge.
• Evaluate the payoff and profit of hedging strategies.
7. For forwards and futures, define and recognize the definitions of the following terms:
• Forward contract, Prepaid forward contract
• Outright purchase, Fully leveraged purchase
• Implied repo rate
• Cost of carry
• Lease rate
• Futures contract
8. For forwards and futures, the candidate will be able to:
• Determine forward price from prepaid forward price.
• Explain the relationship between forward price and futures price.
• Explain the relationship between forward price and future stock price.
• Use the concept of no-arbitrage to determine the theoretical value of futures and forwards.
• Given any four of call premium, put premium, forward price, strike price and interest rate, calculate
the remaining item using the put-call parity formula.
9. For swaps, define and recognize the definitions of the following terms:
• Swap, Prepaid swap
• Swap term, Swap spread, Notional Amount
• Simple commodity swap, Interest rate swap
• Deferred swap
10. Use the concept of no-arbitrage to determine the theoretical values of swaps.

Materials for Study, 2019 Exam 2 Exam 2-5


SYLLABUS OF BASIC EDUCATION
2019
Financial Mathematics – Exam 2

Options for Obtaining Exam 2 Credit

The CAS will grant credit for Exam 2 to those who have successfully completed one of the following
examinations:

Organization Examination

Actuarial Society of South Africa A201, Financial Mathematics

Actuaries Institute (Australia)
Canadian Institute of Actuaries (CIA)
China Association of Actuaries
Institute of Actuaries of India
Institute and Faculty of Actuaries (U.K.)
Society of Actuaries
CT1, Financial Mathematics
University Accreditation Program credit for Financial
Mathematics1
See note below2
CT1, Financial Mathematics
CT1, Financial Mathematics
Exam FM, Financial Mathematics

1. For credit granted through the CIA’s University Accreditation Program, the list of candidates granted
waivers by the CIA is provided to the CAS following the end of a semester. The CAS automatically updates its
records. No further action is required of candidates.

2. The CAS will grant exam waivers based on exams administered by the China Association of Actuaries as a
cohort for CAS Exams 1, 2, and 3F and Validation by Educational Experience requirements – Accounting and
Finance, and Economics. See Waivers of Examination page of the CAS website for a complete waiver
explanation.

To obtain credit otherwise, candidates should follow the procedures outlined on the Waivers of Examination
page of the CAS website.

Materials for Study, 2019 Exam 2 Exam 2-6