THE TIME VALUE OF MONEY

If I invest £100
today how much
will I have in 3
years?

What do I need to consider?.....

Interest Rates
• interest rates are a fundamental part of actuarial work

• interest may be regarded as a reward paid by the

“borrower” for the use of capital belonging to the
“lender”

• some risk of default is compensated by a higher rate

of interest

• possible appreciation/depreciation of currency might

also influence the level of interest rates
The amount of interest payable under a financial arrangement
can be expressed in terms of 2 different types of interest :-

1. Simple Interest
‘ at rate i*100% per annum’
If C is deposited then C(1+ni) is paid after n years
note: interest does not earn interest

10% p.a. 10% p.a. 10% p.a.

£100 £110 ? ?
 2. Compound Interest
‘at rate i*100% per annum’
n
If C is deposited then C(1+i) is paid after n years
note: interest itself earns interest

10% p.a. 10% p.a. 10% p.a.

£100 £110 ? ?
What if I want to know….

How much should I

invest now to
ensure I have £100
in 3 years?

Actuaries call these PRESENT VALUES

Present values (discounted values)

Actuaries are more interested in how much we need

now to provide payments at a later time….

• Pension payments
• Insurance Premiums
Define function

Then the discounted present value of C due at time n is

Present value (PV) = Cvn

3. Simple discount
‘at rate d*100% per annum’
If C is due after n years then sum of money required to
be invested now is
C(1-nd)
In normal commercial practice:-

• d usually encountered for n<1 year

• referred to as “commercial discount”

Investing over a period of time

• define unit of time

• effective rate of interest for period i(t)

The accumulation of C from t = 0 to t = n is

C[1+i(0)][1+i(1)]……………[1+i(n-1)]

If rate of interest per period does not depend on time t

then accumulation becomes

C(1+i) n
A helping hand…
Formulae and tables for actuarial examinations

• referred to as “Tables”

• shows values of vn at various rates of interest

• be careful with rounding

• examples
And now it’s your turn….

Value Interest Rate Calculation Tables

5
𝑣 4%

𝑣 0.5%

39
𝑣 25%