Actuarial Mathematics - Lecture 1

Frank Coolen
Durham University

14 January 2013

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

14 January 2013

1 / 10

Outline of the course

Compound interest; annuities; repaying a debt Lifetime models Life insurance; life annuities Calculating premiums Family income; expenses; reserves; possible further topics

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

14 January 2013

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Course details

Books: Life Insurance Mathematics by Hans Gerber (3rd edition, 1997), Fundamentals of Actuarial Mathematics by David Promislow (2nd edition 2010, 1st edition also ne) Support classes: tutorials (weeks 12, 14, 16, 18) and problems classes (weeks 13, 15, 17, 19) Homework: set once every two weeks, hand-in strict deadline one week later Webpage: http://maths.dur.ac.uk/stats/courses/AMII/am.html

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

14 January 2013

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1. Compound interest

Effective interest rates Nominal interest rates Perpetuities and annuities

The closely related topic of Repayment of a Debt is Homework 1.

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Actuarial Mathematics - Lecture 1

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1.1 Effective interest rates

To specify an interest rate, one needs to dene the basic time unit such as year (e.g. annual interest rate of 6%) and the conversion period at the end of which interest is paid (credited, compounded). If the conversion period is equal to the basic time unit, then the interest rate is called effective, e.g. 6% annual interest rate credited at the end of each year. Such rates are called Annual Effective Rates: AER and denoted by i (e.g. i = 0.06). We assume throughout that i > 0.

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

14 January 2013

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Initial (time 0) amount F0 with AER i leads to Fn = (1 + i )n F0 after n years If you invest a further rk 0 at the end of year k = 1, . . . , n, then Fk = (1 + i )Fk 1 + rk , k = 1, . . . , n which leads to
n

Fn = (1 + i ) F0 +

(1 + i )nk rk
k =1

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Actuarial Mathematics - Lecture 1

14 January 2013

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(1 + i ) is called the accumulation factor and (1 + i )k is called the accumulation value after k years
1 The discount factor v = 1+ i is used to determine the present value (value at time 0) of future amounts. If AER i remains unchanged for the whole period concerned, then the present value of an amount C at the end of time unit k is v k C

Clearly
n

v n Fn = F0 +
k =1

v k rk

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Actuarial Mathematics - Lecture 1

14 January 2013

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1.2 Nominal interest rates

If the basic time unit and the conversion period differ, the interest rate is called nominal. For example, nominal annual interest rate 0.06 with a conversion 06 period of three months (m = 4) means interest of 0.4 = 0.015 (so 1.5%) is credited at the end of each quarter, so initial capital F0 becomes (1 + 0.015)4 F0 = 1.06136F0 after one year. So nominal interest rate of 6% with a quarterly conversion period is equivalent to AER of 6.136%. (Note: the word nominal is often deleted if it is clear what the main time unit is - usually year. For the same reason annual is often deleted.)

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Actuarial Mathematics - Lecture 1

14 January 2013

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Let i (m) be the equivalent nomimal interest rate to AER i with m (equal-length) conversion periods per year (so i (4) = 0.06 corresponds to i = 0.06136 in example above).

(1 +

i (m) m ) =1+i m

i (m) = m[(1 + i )1/m 1]

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

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For i = 0.06 m 1 2 3 4 6 12 52 365 i (m ) 0.06 0.05913 0.05884 0.05870 0.05855 0.05841 0.05830 0.05829 0.05827

Exercise: prove that i (m) is decreasing. Challenge: Derive a formula for lim i (m) .
m

Frank Coolen (Durham University)

Actuarial Mathematics - Lecture 1

14 January 2013

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