Course Title: Elements of actuarial science Core Course: IV (Semester-VI) Course Code: 20US6STEA4

Module-1: Annuity Certain

To open and run a business, a person initially needs some huge amount of money. The amount
needed is borrowed from a bank or some other source, with a promise to return the same, with extra
amount, after certain time.
The initial borrowed amount is called principal or capital or present value (p.v.) or discounted value.
The time for which it is used is called “Period”.
The extra amount payable after some period is called “Interest”.
(Principal + Interest) at the end of the period is called Maturity amount or accumulated value (a.v.)
or future value (f.v.).
Present Value & Future Value: The current worth of a future sum of money is called Present Value.
Present Value is the current value of a future amount of money, or a series of payments, evaluated at a
given interest rate. Present value is also called “Discounted value" or “Principal”. Future sum of money
is called Accumulated Value. Future value is the value of an asset or cash, at a specified date in the
future, which is equivalent in value, to a specified sum today.
Interest: Interest is a charge for borrowing money, usually stated as a percentage of the amount
borrowed over a specific period of time.
Discount: Future sum of money is discounted at the discount rate, to get present value. Higher the
discount rate, the lower the present value. The interest rate used in discounted cash flow analysis, to
determine the present value of future cash flows, is called Discount Rate.
Methods of calculating Interest
i) Simple Interest: Simple interest is calculated on the original principal only. Accumulated
interest from prior periods is not used in calculations for the following periods i.e. unpaid interest, does
not earn interest, over subsequent period.
ii) Compound Interest: Compound interest is calculated each period on the original principal and
all interest accumulated during past periods. Compound interest can be considered as a series of
back-to-back simple interest contracts. The interest earned in each period is added to the principal of
the previous period to become the principal for the next period i.e. unpaid interest over any unit of
time, is also assumed to earn interest over the subsequent units of time. Therefore total interest is
more than the corresponding simple interest reckoned at the same rate.

Year Value at the beginning SI CI Value at the end of the year

of the year P = 10,000 (Using CI)
(1) (2) (3) = P * 0.05 (4) = (2) * 0.05 (5) = (2) + (4)
1 10,000 10000* 0.05 = 500 10000* 0.05 = 500 10,500
2 10,500 10000* 0.05 = 500 10500* 0.05 = 525 11,025
3 11,025 10000* 0.05 = 500 11025* 0.05 = 11576.25
551.25
Total 1500 1576.25

∴ Total SI = Rs.1500 and a.v. using SI = 10000 + 1500 = Rs. 11500

Total CI = Rs.1576.25 and a.v. using CI = 10000 + 1576.25 = Rs. 11576.25=S
 Course Title: Elements of actuarial science Core Course: IV (Semester-VI) Course Code: 20US6STEA4

Formula to calculate SI:

Simple Interest (SI) = (P * i * n)

∴Accumulated Value = P + SI
Where:
P = principal (original amount borrowed or loaned or present value)
i = interest rate for one period (Usually per annum i.e. per year)
n = number of periods

Example: You borrow Rs. 10,000 for 60 days at 5% simple interest per year (assume a 365 days year),
then P = Rs. 10,000 i = 0.05 per year n = 60 days = (60/365) year
SI = p * i * n = 10,000 *0.05 * (60/365) = Rs. 82.19 and
a.v. = P +SI = 10,000 + 82.19 = Rs. 10,082.19
Formula to calculate CI:
Let a principal of Re.1/- is invested, at a rate of interest ‘i’ per annum (p.a.)
∴ a.v. of Re. 1/- at the end of 1st year = (1 + i) = x1 (say)
This ‘x1’ becomes principal amount for the 2nd year
∴ Interest at the end of 2nd year = x1 * i
∴ a.v. at the end of 2nd year = x1 + x1 * i = x1* (1 + i) = (1 + i) *(1 + i) =(1 + i)2 = x2 (say)
This ‘x2’ becomes principal amount for the 3rd year
∴ Interest at the end of 3rd year = x2 * i
∴ a.v. at the end of 3rd year = x2 + x2 * i = x2* (1 + i) = (1 + i)2 *(1 + i) =(1 + i)3
Continuing in this way we get,
a.v. of Re.1/- at the end of ‘n’ years = (1 + i)n
In general, if principal of Rs.P is invested at the beginning of the year, then
S = a.v. of Rs.P at the end of ‘n’ years = P*(1 + i)n
A.V.= S = P*(1 + i)n
Compound Interest earned = A.V. – P.V. = S – P
We can say that, amount of ` S payable after ‘n’ years is equivalent to the payment of ` P at the present
moment. Therefore ‘P’ is called PV of the sum of money of ` S payable at some future date.

S = P * (1 + i)n


∴ P = () = S vn Where v = ()
PV = FV * vn

‘v’ is called present value of Re. 1 payable at the end of one year.