Force Of Interest

Background:
The force of interest is a fundamental concept used in various fields,
including actuarial science, finance, and mathematics. It is closely
related to the idea of compounding, which involves calculating the
interest earned on an investment or debt and then reinvesting or
accruing interest on both the principal amount and any previously
earned interest.
In traditional compounding, the interest is typically added at fixed
intervals (e.g., annually, quarterly, or monthly). However, the force of
interest introduces the concept of continuous compounding, where
interest is added to the investment or debt continuously, without any
fixed time intervals.

Definition:
The force of interest (δ) is defined as the instantaneous rate at which
interest is earned or accumulated on an investment or debt at any
given moment in time. It represents the continuous compounding
rate.
In mathematical terms, if A(t) is the accumulated amount at time t
for an initial amount A(0), then the relationship between A(t) and
A(0) is given by:
A(t)= A(0)×eδt
where:
e is Euler's number, the base of the natural logarithm (approximately
equal to 2.71828).
t is the time elapsed in years.
Interpretation:
The force of interest provides a way to understand the rate at which
an investment grows or a debt increases on a continuous basis.
Unlike traditional compounding with fixed intervals, which results in
discrete changes to the accumulated amount, continuous
compounding leads to a smooth and uninterrupted growth.
To better understand the interpretation of the force of interest,
consider the following example:

Let's say you have $1,000 invested in an account that earns a

continuous interest rate of 5% per year. To calculate the value of the
investment after 3 years, you can use the formula:

A(t)=1000×e0.05×3
A(t)=1000×e0.15
Using a calculator, you find A(t)≈1000×1.16183≈1161.83.
So, after 3 years of continuous compounding at 5% force of interest,
your investment would grow to approximately $1,161.83.