Actuarial science

Interest rate = Real rate + Inflation

1. Pricing of the products
2. Valuation of liabilities

Fundamentals of pricing Present value of cash flow will b

Amoount to be received 100.0 100.0 103000

Time in years 1.0 3.0 1
Interest rate 5% 5% 5%
Amount in hand 95.2 86.4
98,095 <--PV
Proposal 0: Pay 97 today and get 100 next year

Proposal 1:
Pay Rs.90 today and get Rs.100 three years from now

Proposal 2: Premium
Pay Rs.185 and get two returns: 181.62 185.0
Rs.100 at end of year 1 95.2
Rs.100 at end of year 3 86.4

Equation of fair value

Sum of present value of all cash inflows = Sum of PV of all cash outflows

Pricing of fixed income instruments

A corporate bond pays a coupon of 6% per annum

It has three years to maturity
Investors expect a return of 8% from such bonds Inflow
Face value of bond: 100 Coupon / Interest
Maturity amount / face value
Rate of return 8% <-- Based on required return
Outflow
Year CF In PV Purchase price = PV of purchas
1 6.0 5.56
2 6.0 5.14 Fair Purchase price = Present v
3 106.0 84.15
94.85 <-- Fair value of the bond

Pricing of fixed income instruments

A corporate bond pays a coupon of 6% per annum
It has three years to maturity
Face value of bond: 100
Investors expect following interst rate for different tenures

Year Int Rate CF In PV

1 5.0% 6.0 5.71
2 6.0% 6.0 5.34
3 8.0% 106.0 84.15
95.20

Pricing of fixed income instruments

An investment scheme offers Rs.1000 each at the end of years 3, 4, and 5
The investor needs to invest a certain in two instalments of equal amount
One instalment payable right away and another instalment is payable at end of year 1

Find the amount payable if interest rate is 6%

Int rate 6%

Year CF In PV of CFIn PV of CFOut

0 - 1.00X
1 0 - 0.94X
2 0 -
3 1000 840
4 1000 792
5 1000 747

2,379 1.94X

2,379 = 1.94X
X 1,224.1

Pricing of fixed income instruments

An investor has to pay three annual instalments starting now. First payment has to happen now
At the end of third year, the investor would get Rs.60,000

The following are the prevailing interest rates in the mark

Year Int rate CF In PV of In PV of Out

0 - 1.00X =1/(1+C93)^B93
1 5% - - 0.95X =1/(1+C94)^B94
2 6% - - 0.89X =1/(1+C95)^B95
3 8% 60,000 47,629.93 0

47,629.93 2.84X =SUM(F93:F96)

X= 16,757 =E98/F98
= Real rate + Inflation

Present value of cash flow will be lesser than actual cash to be received in future

𝑃𝑉=𝐹𝑉/(1+𝑟)^𝑛 𝐹𝑉=𝑃𝑉∗(1+𝑟)^𝑛
𝑟=(𝐹𝑉/𝑃𝑉)^(1/𝑛)−1

Cash back Fair value

-3.38 181.62

NPV of a project @ 12% discount rate = 0 (No excess profit)

Are you earning any profit at all in this project (in accounting terms)
What is the rate of return you are earning?

Coupon / Interest
Maturity amount / face value

Purchase price = PV of purchase price (as it is paid now)

Fair Purchase price = Present value of all coupon + Present value of maturity amount
s payable at end of year 1

ment has to happen now

Entry fee - - 150.0

Outcome Bet 1 Bet 2 Bet 3 P(X)

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Total 100.00%
Entry fees
Net Profit

Expected value #NAME? #NAME? #NAME?

Expected outcome = Sum (Possible Outcomes * Probability of outcomes)

A company wants to take a group life insurance policy
The company has 1000 employees
The policy tenure is 3 years
All policy claims will have to be paid only at the end of year 3

The claim shall be Rs.1,00,000 to be payable of every deceased person

99% of the employees are expected to survive the 3 years

If the interest rate is 6%, calculate the fair premium

No. of employees 1000

survival rate 99%
Death rate 1%

No. of claims 10.00

Claim 100,000
Death benefit 1,000,000

Survival benefit 3,000

Tot. survival benefit 2970000

Time 3
Discount rate 6%

Present value 3,333,289

Time PV of X
0 1.00X
1 0.94X
2 0.89X
2.83X

Annual premium 1,176,430

1,176.43

A company wants to take a group life insurance policy

The company has 1000 employees
The policy tenure is 3 years
All policy claims will have to be paid only at the end of year 3

The claim shall be Rs.1,00,000 to be payable of every deceased person

99% of the employees are expected to survive the 3 years
The employees surviving will be paid Rs.3,000 per person at end of 3 years

The insurance premium will be payable in 3 annual instalments starting now

If the interest rate is 6%, calculate the fair annual premium

No. of employees 1000

survival rate 99%
Death rate 1%

No. of claims 10
Claim 100,000
Total claim payable 1,000,000

Time 3
Discount rate 6%

Present value 839,619

No. of employees 1000
Survival rate 99%
Death rate 1%

No of Claims 10
Claim 100,000
Total Claim 1000000
Survivors 990
Claims 3000
Total Claims 2970000

Time 3
Discount Rate 6%

Present Value 3333289

Time PV of X
0 1.00X
1 0.94X
2 0.89X
2.83X
A 25 year old wants to sign up for a 3 year insurance policy
The sum assured would be Rs.1,00,000
The claim is payable at the end of the year of death

Interest rate is 6%.

Year Unconditi Exp pmt PV of P(S) PV of

onal outflow inflow
P(Death)
0 100.0% 100.00%X
1 0.20% 200 188.7 99.8% 94.15%X
2 0.30% 300 267.0 99.5% 88.55%X PV of outlfow = PV of i
3 0.35% 350 293.9
749.5 = PV of inflows
749.5 282.71%X 749.5 = PV of (100%X

Premium per annum 265.13

Calculate the single premium

Calculate if the premiums were payable at beginning of year
If a person dies, the claims are paid and contract is closed .. No future premium is received

Matches played 400

Innings 325

No. of centuries 25

Probability of scoring centure in next math 7.69% chances if the person gets to bat
Probability of getting to bat 81.25%
6.25% Unconditional probability
6.25% Unconditional probability

25/325 * 325/400 25/400

 PV of outlfow = PV of inflow

749.5 = PV of inflows
749.5 = PV of (100%X, 99.8%X, 99.5%X)

premium is received

he person gets to bat

nal probability
nal probability
 Claims

Amount
Premium

Life
Claims

Premium