FM for Actuaries

1
Interest
Accumulation and
Time Value of Money
From time to time we are faced with problems of making financial
decisions. These may involve anything from borrowing a loan from
a bank to purchase a house or a car; or investing money in bonds,
stocks or other securities. To a large extent, intelligent wealth management
means borrowing and investing wisely.
Financial decision making should take into account the time value of
money. It is not difficult to see that a dollar received today is worth
more than a dollar received one year later. The time value of money
depends critically on how interest is calculated. For example, the
frequency at which the interest is compounded may be an important
factor in determining the cost of a loan.
In this chapter, we discuss the basic principles in the calculation of
interest, including the simple- and compound-interest methods, the
frequencies of compounding, the effective rate of interest and rate of
discount, and the present and future values of a single payment.