EPV of increase in reserves=EPV of interest earned on them?

[Kunjesh Parikh]

How is the epv of increase in reserves equal to epv of interest earned on reserves possible?

 

[Mark Mitchell]

I'm not sure I understand what you're asking here. I think you'll need to give a course reference, or an example of a question...

 

[Kunjesh Parikh]

I'm not sure I understand what you're asking here. I think you'll need to give a course reference, or an example of a question...

This solution is part of IAI QP MAY 2009 Question No. 7 (ii). It asked to calculate the present value of profit at the start of contract where PV of profit was defined in the question itself (which also appeared strange to me as to why the expression was given when it is the standard way) and the solution to the question quotes :"that epv of increase in reserves will be equal to epv of interest earned on reserves if the interest earned on reserves and the interest rate used to discount the reserves are same" . How?

 

[Robert Chadburn]

Imagine you have a profit of 100 now. But instead of being able to spend that profit, you have to place it in reserve for one year (ie you are holding a reserve of 100 for one year). What is the EPV of the profit now?
It will be 100x(1+i)/(1+r), where i=interest rate earned on reserves, and r=risk discount rate.
So, when i=r, the EPV of the profit stays the same (=100). But in the more normal case where i<r, the EPV is less than 100.
But in this question, i=r, so the holding of any amount of reserves will make no difference to the EPV of the total profit.
Robert