CT5 Chapter 12 Example on page 3

Every year the company deducts 1% from the bid value of the fund. The charge is made monthly in arrears (ie at the end of each month {1.01^(1/12)-1}
of the bid value of the units is deducted).

Question: why is the deduction for each month {1.01^(1/12)-1} of the bid value?
In my opinion, the deduction should be {1-0.99^(1/12)}.

Anyone can help me
Thank you.

 

Since the formula is as follows

(1+ip/p)^p = (1+i)
(1+ip/p) = (1+i)^(1/p)
ip/p = (1+i)^(1/p) - 1

 

Thank you.
But { i } represents the interest rate, which is positive. However, here the deduction rate is negative.
Why can we treat the interest rate and the deduction rate as the same thing.

my confusion actually can be illustrated in the following way:
we have deduction rate {1.01^(1/12)-1} per month. therefore the annual deduction is { (1- monthly deduction rate)^12 }, i.e. (2-1.01^(1/12))^12, which is apparently not equal to 99%.
However, if we have deduction rate {1-0.99^(1/12)} per month, then the annual deduction is 99%, which means that we have deducted 1% from the bid value.


which part of my opinion is incorrect？

 

Yes your view point is correct they should have used the discounting formula whereas they are using interest
formula, when i again thought on your reply so yes what you want to say is also correct, but just think
in this way in real life bid value also changes with market fluctuations so its not only that bid value
is reducing on account of deduction its also increasing or decreasing due to market fluctuations,
so if you assume that bid value stays same through out the year then your opinion is correct of using
discount rate and then formula should become like this

(1-(1-0.01)^(1/12))

 

Thanks a lot.
So when we face similar questions in the exam, which formula should we use, interest formula or discounting formula?

 

Well let me say that i have not faced any such question in the profit testing where they have asked
us to charge the expenses on monthly basis, so i donot think they will give any such question of
profit testing where they will go for monthly basis rather than annually.

As far as this question concerned so this is just an example, they have not based any
question on this example.

 

Thank you very much.