Course Notes

MACS 101
Introduction to Actuarial Science
Xavier University
Course Notes: The course notes are based on the Finan

textbooks.
Last Updated: January 5, 2019

CONTENTS MACS 101
Contents
1 Introduction to Actuarial Science 2
1.1 What is Actuarial Science? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.2 What do Actuaries Do? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
1.3 Why Actuarial Science? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.4 Accrediting Agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
1.4.1 Casualty Actuarial Society (CAS) . . . . . . . . . . . . . . . . . . . . 3
1.4.2 Society of Actuaries (SOA) . . . . . . . . . . . . . . . . . . . . . . . . 4
1.5 Actuarial Exams . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
1.6 Motivating Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
2 The Meaning of Interest 7
3 Accumulation and Amount Functions 13
4 Effective Interest Rate 21
5 Simple Interest 27
6 Date Conventions Under Simple Interest 34

6.1 Exact Simple Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
6.2 Ordinary Simple Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
6.3 Banker’s Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
1
1 INTRODUCTION TO ACTUARIAL SCIENCE MACS 101
1 Introduction to Actuarial Science
Note: Chapter 1 of the course notes is based on the following sources:
• “Be an Actuary” at beanactuary.org
• “Actuarial Outpost” at actuarialoutpost.com.
• “Society of Actuaries” at https://www.soa.org/Member/.
• “Investopedia” at https://www.investopedia.com/terms/a/actuarial-science.asp.
1.1 What is Actuarial Science?
(i) From the Investopedia website: “Actuarial science is a discipline that assesses fi-
nancial risks in the insurance and finance fields, using mathematical and statistical
methods.”
(ii) Actuarial science is a blend of mathematics, statistics, finance, and economics that
focuses on analyzing and dealing with potential risks.
(iii) People who study actuarial science are referred to as “actuaries.”
1.2 What do Actuaries Do?
(i) From the SOA website: “Actuaries measure and manage risk. Actuaries have a deep
understanding of mathematics, statistics and business management. With this, they
help businesses grow and provide value to their customers. Actuaries help leaders
make strategic decisions and consumers prepare for their future.”
(ii) From the SOA website: “Actuaries are highly sought-after professionals who develop
and communicate solutions for complex financial issues.”
(iii) From the Be an Actuary website: “With unbeatable analytical skills, we help or-
ganizations plan for the future and protect themselves from loss. By understanding
the very nature of risk, we play a key role in the psychological, physical, and finan-
cial stability of society. With our help, businesses can grow, retirees can invest with
confidence, and people can enjoy peace of mind.”
2
(iv) From the Be an Actuary website: Actuaries are experts in
• “Evaluating the likelihood of future events-using numbers, not crystal balls”
• “Designing creative ways to reduce the likelihood of undesirable events.”
• “Decreasing the impact of undesirable events that do occur.”
(v) Video posted on the Be an Actuary website:

https://www.youtube.com/watch?v=MdgQCBTT RY&t=47s.
1.3 Why Actuarial Science?
(i) Video posted on the Be an Actuary website:

https://www.youtube.com/watch?v=BP3DqGSAW2s.
1.4 Accrediting Agencies
(i) Two US accrediting agencies:
• Casualty Actuarial Society (i.e., CAS)
• Society of Actuaries (i.e., SOA).
(ii) Actuaries are typically required to be accredited to one of these agencies.
(iii) Each agency has its own role, exams, disciplines, ethical standards, rules, etc.
(iv) The first three exams (P, FM, IFM) are the SAME for both agencies.
(v) After you pass the third exam, you have to choose which route (i.e., CAS or SOA)
you want to go.
1.4.1 Casualty Actuarial Society (CAS)
(i) Smaller of the two agencies.
(ii) Houses actuaries working in property insurance, auto insurance, liability, business
insurance, property insurance, etc.
(iii) “Shorter” insurance.
(iv) Only one track.
3
(v) Two designations:
(a) Associate of the CAS (ACAS)
(b) Fellow of the CAS (FCAS).
1.4.2 Society of Actuaries (SOA)
(i) Larger of the two agencies.
(ii) Houses actuaries working in health insurance, life insurance, pensions, retirement, etc.
(iii) “Longer” insurance.
(iv) There are six unique tracks (i.e., specializations). They are
(a) Corporate Finance and ERM Track (i.e., CFE)
(b) Quantitative Finance and Invenstment Track (i.e., QFI)
(c) Individual Life and Annuities Track
(d) Retirement Benefits Track
(e) Group and Health Track
(f) General Insurance Track.
(v) More information about the different tracks:

https://www.soa.org/Education/Exam-Req/edu-fsa-req.aspx
(vi) Different exams are required for each track.
(vii) Two designations:
(a) Associate of the SOA (ASA)
(b) Fellow of the SOA (FSA).
4
1.5 Actuarial Exams
(i) Preliminary Exams: Exam P (i.e., probability), Exam FM (i.e., Financial Mathe-
matics), and Exam IFM (i.e., Investment and Financial Markets) are must pass for all
actuaries independent of route.
(ii) Can be taken in any order.
(iii) At Xavier University, we’d like to see you have two exams passed before gradu-
ation and your first exam passed before the end of your sophomore year.
(iv) The preliminary exams are multiple choice. The upper level exams are written.
(v) Each is scored 0-10; 6 is a pass grade.
(vi) Offered every 2-6 months, depending on the exam.
(vii) Don’t get discouraged!
(viii) Exam study sources:
(a) Couching Actuaries at https://www.coachingactuaries.com/
(b) Infinite Actuary at https://www.theinfiniteactuary.com/
(c) Actuarial Study Materials at http://www.studymanuals.com/
(d) Other students who have passed!
(e) Real actuaries!
(ix) Once you have an exam passed, apply for and participate in at least one actuarial
internship!
(x) Exam P is 3 hours and comprised of 30 questions.
(xi) Exam FM is 3 hours and comprised of 35 questions.
(xii) Exam IFM is 3 hours and comprised of 30 questions.
5
1.6 Motivating Problem
From the front-page of beanactuary.org:
A device runs until either of two components fails, at which point the device
stops running. The joint density function of the lifetimes of the two components,
both measured in hours, is
f (x, y) = (x + y)/8 for 0 < x < 2 and 0 < y < 2.
What is the probability that the device fails during its first hour of operation?
A. 0.125
B. 0.141
C. 0.391
D. 0.625
E. 0.875
6
2 THE MEANING OF INTEREST MACS 101
2 The Meaning of Interest
Motivation: When a bank lends money to you, it charges rent for the money. When you
lend money to a bank (also known as making a deposit in a savings account), the bank pays
rent to you for the money. In either case, the rent is called “interest.”
• Formally, interest is an amount charged to a borrower for the use of the lender’s
money over a period of time.
• The money the lender is investing is changing value with time due to the interest
being added. For that reason, interest is sometimes referred to as the “time value
of money.”
Definitions:
(i) Principal (P ): The money invested in financial transactions.
(ii) Amount Value (A): The amount P has grown to be.
(iii) Amount of Interest (I): The amount earned during the period of investment.
I = A − P.
(iv) Interest Rate: Interest expressed as a percent of the principal.
(v) Collateral: Interest takes into account the risk of default (risk that the borrower can’t
pay back the loan). The risk of default can be reduced if the borrower’s promise to
release an asset of theirs in the event of their default (the asset is called collateral).
(vi) Measurement Period: The unit in which time of investment is measured.
• Common measurement periods:
7
Example 2.1. Let A(t) denote the amount value of an investment at time t years.
(a) Write an expression giving the amount of interest earned from time t to time t + s in
terms of A only.
(b) Use (a) to find the annual interest rate, i.e., the interest rate from time t years to time
t + 1 years.
Example 2.2. You deposit $1,000 into a savings account. One year later, the account
has accumulated to $1,050.
(a) What is the principal in this investment? Use correct notation.
(b) What is the interest earned? Use correct notation.
(c) What is the annual interest rate?
Motivation: Interest rates are often computed on an annual basis, but can also be
determined for non-annual time periods as well. What non-annual time periods can you
think of?
8
Example 2.3. You deposit $1,000 into a savings account using a bank that offers an
annual interest rate of 10% “compounded semi-annually.”
(a) After 6 months, what is your account balance?
(b) After 1 year, what is your account balance?
(c) What is the annual interest rate?
Definition: When interest is calculated on the original principal only it is called simple
interest. Accumulated interest from prior periods is not used in calculations for the fol-
lowing periods. In this case, the amount value A, the principal P , the period of investment
t, and the annual interest rate i are related by the formula
A = P (1 + it).
Example 2.4. At what rate will $500 accumulate to $615 in 2.5 years?
9
Definition: Compounding is the process of adding accumulated interest back to the

principal, so that interest is earned on interest from that moment on. In this case, we have
the formula
A(t) = P (1 + i)t
and we call i a yearly compound interest. You can think of compound interest 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.
Example 2.5. You borrow $10,000 for three years at 5% annual interest compounded
annually. What is the amount value at the end of three years?
10
Problem Set 1
(1) You borrow $12,000 from a bank. The loan is to be repaid in full in one year’s time
with a payment due of $12,780.
(a) What is the interest amount paid on the loan?
(b) What is the annual interest rate?
(2) Using the compound interest formula, what annual interest rate would cause an invest-
ment of $5,000 to increase to $7,000 in 5 years?
(3) Using the compound interest formula, how long would it take for an investment of
$15,000 to increase to $45,000 if the annual compound interest rate is 2%?
(4) Suppose $100 is invested into two accounts. Account A pays 5% interest and account
B pays 10% interest. Calculate the accumulated amount in each account at the end
of year 1, 2, 3, and 4 under simple interest and compound interest. Fill in the tables
below. What do you notice?
Account A (5% Simple Interest) Account A (5% Compound Interest)
Year 1
Year 2
Year 3
Year 4
Account B (10% Simple Interest) Account B (10% Compound Interest)
Year 1
Year 2
Year 3
Year 4
11
This is a Blank Page for Problem Set 1
12
3 ACCUMULATION AND AMOUNT FUNCTIONS MACS 101
3 Accumulation and Amount Functions
Motivation: Imagine a fund growing at interest. It would be very convenient to have

a function representing the accumulated value, i.e. principal plus interest, of an invested
principal at any time.
• Unless stated otherwise, we will assume that the change in the fund is due to interest
only. That is, no deposits or withdrawals occur during the period of investment.
Definitions:
(i) If t is the length of time, measured in years, for which the principal has been invested,
then the amount of money at that time will be denoted by A(t). This is called the
amount function.
(a) What is A(0)?
(ii) In order to compare various amount functions, it is convenient to define the function
A(t)
a(t) = .
A(0)
This is called the accumulation function.
(iii) The accumulation function represents the special case of an initial principal of 1
unit.
Example 3.1. What are the accumulation and amount functions for simple and compound
interest?
13
Properties of a(t):
(i) a(0) = 1.
(ii) a(t) is an increasing function. This means . . .
(iii) A decreasing accumulation function means . . .
(iv) A increasing accumulation function means . . .
(v) A constant accumulation function means . . .
(vi) If interest accrues for non-integer values of t, i.e. for any fractional part of a year, then
a(t) is a continuous function.
(vii) If interest does not accrue between interest payment dates then a(t) possesses discon-
tinuities. That is, the function a(t) stays constant for a period of time, but will take a
jump whenever the interest is added to the account, usually at the end of the period.
The graph of such an a(t) will be a step function.
14
Example 3.2. You are given the following amount function: A(t) = t2 + 100. Determine
the amount of interest earned in the 5th year. What about after 5 years?
Example 3.3. Suppose that A(t) = αt2 +10β. If $X is invested at time 0 and accumulates
to $500 at time 4, and to $1,000 at time 10, find the amount of the original investment, X.
15
Comment: Property (ii) (increasing function) and (vi)/(vii) (either continuous or a step
function) hold for the amount function A(t).
Motivation: The amount function A(t) gives the accumulated value of k invested/de-
posited at time 0. What if k is not deposited at time 0, but at time s > 0?
Definition: In general, if $k is deposited at time s, then the accumulated value of $k at

time t > s is
a(t)
k× ,
a(s)
where a(t)/a(s) is called the accumulation factor or growth factor.
Example 3.4. Suppose $100 is deposited into an account at time 2. This is the same as
considering a deposit of $k made at time 0 such that $k grows to $100 at time 2. How much
does the $100 grow by time 4? Calculate this in two ways.
Example 3.5. A person borrows $2,000 for 3 years at simple interest. The rate of interest
is 8% per annum. What are the interest charges for years 1 and 2? What is the accumulated
amount at the end of year 3?
16
Example 3.6. It is known that the accumulation function a(t) is of the form a(t) =
b(1.1)t + ct2 , where b and c are constants.
(a) If $100 invested at time t = 0 accumulates to $170 at time t = 3, find the accumulated
value at time t = 12 of $100 invested at time t = 1.
(b) Show that a(t) is increasing.
17
Definition: Suppose n is a positive integer. The nth period is defined to be the period of
time between t = n − 1 and t = n. More precisely, the period normally will consist of the
time interval n − 1 ≤ t ≤ n. Furthermore, the interest earned during the nth period of
time (n a positive integer) is given by
In = A(n) − A(n − 1).
• This says that interest earned during a period of time is the difference between the
amount value at the end of the period and the amount value at the beginning of the
period.
• Important distinction: In involves the effect of interest over an interval of time;

A(n) is an amount at a specific point in time.
• Draw a figure that corresponds to the previous definition.
Result: In general, the amount of interest earned on an original investment of $k between

time s and t is
I[s,t] = A(t) − A(s) = k (a(t) − a(s)) .
Example 3.7. Consider the amount function A(t) = t2 + 2t + 1. Find In in terms of n.
18
Problem Set 2
(1) An investment of $1,000 grows by a constant amount of $250 each year for five years.
(a) What does the graph of A(t) look like if interest is only paid at the end of each
year?
(b) What does the graph of A(t) look like if interest is paid continuously and the amount
function grows linearly?
(2) Interpret the following result verbally:
A(n) − A(0) = I1 + I2 + · · · + In .
(3) It is known that a(t) is of the form at2 + b. If $100 invested at time 0 accumulates to
$172 at time 3, find the accumulated value at time 10 of $100 is invested at time 5.
(4) Suppose that a(t) = 0.10t2 + 1. The only investment made is $300 at time 1. Find the
accumulated value of the investment at time 10.
(5) Consider the accumulation functions as (t) = 1 + it and ac (t) = (1 + i)t where i > 0.
Show that for 0 < t < 1, ac (t) ≈ as (t). That is, show
(1 + i)t ≈ 1 + it.
Hint: Graph? Power series expansion of (1 + i)t ?
19
20
4 EFFECTIVE INTEREST RATE MACS 101
4 Effective Interest Rate
Motivation: Thus far, interest has been defined by
Interest = Accumulated value - Principal.
This definition is not very helpful in practical situations, since we are generally interested
in comparing different financial situations to figure out the most profit.
• That is, if one investment pays 10%, compounded monthly, and another investment
pays 10.1% compounded semi-annually, then which investment will actually pay more
over the course of the year? over the course of 10 years?
• To help determine this, we compute the effective interest rate.
Definition: The effective interest rate is the amount of money that one unit invested at
the beginning of a period will earn during the period, with interest being paid at the end
of the period.
• If i is the effective interest rate for the FIRST time period, then we can write
i = a(1) − a(0) = a(1) − 1,
where a(t) is the accumulation function.
Remarks:
• We will assume the principal (P ) remains constant during the period; that is,
there is no contribution to the principal or no part of the principal is withdrawn during
the period.
• The EIR is a measure in which interest is paid at the end of the period compared to
discount interest rate where interest is paid at the beginning of the period.
• Show that i can be written in terms of the amount function A(t) as:
A(1) − A(0) I1
i= = .
A(0) A(0)
21
Alternative definition: The effective interest rate for a period is the amount of inter-
est earned in one period divided by the principal at the beginning of the period.
Definition: The effective interest rate in the nth period is defined by
A(n) − A(n − 1) In
in = = .
A(n − 1) A(n − 1)
• Note that In represents the amount of growth of the function A(t) in the nth period
whereas in is the rate of growth (based on the amount in the fund at the beginning
of the period).
• Summing up: The effective interest rate in is the ratio of the amount of interest
earned during the period to the amount of principal invested at the beginning of the
period.
• For any accumulation function, it must be true a(1) = 1 + i.
Example 4.1. Assume that A(t) = 100(1.1)t . Find the effective interest rate in the 5th
period, i5 .
Example 4.2. Using the definition of in , solve for A(n) and interpret this equation.
22
Example 4.3. Using the result from the previous example, convince yourself that A(n)
can be written as
A(n) = (1 + i1 )(1 + i2 )(1 + i3 ) · · · (1 + in )A(0).
Example 4.4. If A(4) = $1, 000 and in = 0.01n, find A(7).
Example 4.5. Write in in terms of a(t).
23
Example 4.6. Suppose a(n) = 1 + in for n ≥ 1. Show that in is a decreasing function of

n.
Example 4.7. Suppose in = i for all n ≥ 1. Show that a(n) = (1 + i)n .
Remark: In the discussion above, the interest rate is associated with one complete
period.
• This will be contrasted later with “nominal rates,” that are stated for one period,
but need to be applied to fractional parts of the period.
• Most loans and financial products are stated with nominal rates such as a nominal
rate that is compounded daily, or monthly, or semiannually, etc. Chapter 9.
24
Problem Set 3
(1) An initial deposit of $500 accumulates to $520 at the end of one year and $550 at the
end of the second year. Find i1 and i2 .
(2) You buy a house for $200,000. A year later you sell it for $160,000. What is the effective
rate of return on your investment? What does this value indicate?
(3) A fund is earning 5% simple interest. Calculate the effective interest rate in the 6th
year.
(4) Assume that A(t) = 100 + 5t, where t is in years.
(a) Find the principal.
(b) How much is the investment worth after 5 years?
(c) How much is earned on this investment during the 5th year?
(5) Consider the amount function A(t) = 12(1.01)4t .
(a) Find the principal.
(b) Find the effective annual interest rate.
25
26
5 SIMPLE INTEREST MACS 101
5 Simple Interest
Motivation: In this section, we discuss a specific accumulation function: the accumulation

function of “simple” interest. Consider an investment of $1 such that the interest earned in
each period is constant and equals i.
• At the end of the first period, what is a(1), the accumulated value?
• At the end of the second period, what is a(2), the accumulated value?
• At the end of the nth period, what is a(n), the accumulated value?
• a(n) is a linear function.
Definition: The accruing of interest according to a(n) = 1 + in is called simple interest.

Furthermore, the effective rate of interest i = a(1) − 1 is called the simple interest rate.
Example 5.1. Suppose a(n) is a linear function as given above. Derive the effective
interest rate, in .
27
Example 5.2. Show that in+1 − in < 0. That is, even though the rate of simple interest
is constant over each period of time, the effective rate of interest per period is not constant;
in fact, it is decreasing from each period to the next. Thus, simple interest is less favorable
to the investor as the number of periods increases. Moreover, the effective rate of interest
converges to 0 in the long run!
Example 5.3. A fund is earing 5% simple interest. Calculate the effective interest rate
in the 6th year.
Remarks:
• For simple interest, the absolute amount of interest earned in each time interval, i.e.,
In = a(n) − a(n − 1) is constant.
• in decreases in value as n increases.
• So far, a(n) for simple interest has only been defined for integral values (integers)
n ≥ 0. What about nonintegral values for n?
– This is equivalent to crediting interest proportionally over any fraction of a period.
– If interest accrued only for completed periods with no credit for fractional periods,
then the accumulation function becomes a step function.
• Unless stated otherwise, it will be assumed that interest is allowed to accrue over
fractional periods under simple interest.
28
Motivation: We now wish to define a(t) for real numbers t ≥ 0. To do this, we need to
redefine the rate of simple interest in such a way that the previous definition is a consequence
of this general assumption:
• Under simple interest, the interest earned by an initial investment of $1 in all time
periods of length t + s is equal to the sum of the interest earned for periods of lengths
t and s. How do we express this symbolically?
Note: The above result holds for periods of any non-negative length, not just integer length.
Example 5.4. Carefully use the result above to argue that for all non-negative real
numbers t, the simple interest accumulation function is
a(t) = 1 + it, t ≥ 0.
29
Example 5.5. You invest $100 at time 0 at an annual simple interest rate of 10%. What
is the accumulated value after 6 months? after 9 months?
Example 5.6. Simple interest is in general inconvenient for use by banks. Sup-
pose John deposits $100 into a savings account that pays 6% simple interest for 2 years.
Peter also deposits $100 with the same bank and at the same simple interest rate. However,
at the end of the first year, Peter withdraws his balance and closes his account. He then
reinvests the total money in a new savings account offering the same rate. Who has the
greater accumulated value at the end of the two years?
Connection: Simple interest is actually a good approximation of compound interest.
• As we will see in chapter 6, the accumulation function for compound interest i

is given by a(t) = (1 + i)t .
• Using the binomial formula, the series expansion of a(t) is
t(t − 1) 2 t(t − 1)(t − 2) 3

(1 + i)t = 1 + it + i + i + ··· .
2! 3!
• Thus, (1 + i)t ≈ 1 + it.
30
Example 5.7. Suppose $10,000 is invested for four months at 12.6% interest compounded
annually. Thus,
A(t) = 10000(1 + 0.126)t .
(a) Find the exact accumulated value after four months.
(b) Using the first two terms of the series expansion of a(t), find the accumulated value
after four months.
(c) Using the first three terms of the series expansion of a(t), find the accumulated value
after four months.
31
Problem Set 4
(1) You invest $100 at time 0 at an annual simple interest rate of 9%.
(a) Find the accumulated value at the end of the fifth year.
(b) How much interest do you earn in the fifth year?
(2) What principal will earn interest of $100 in 7 years at a simple interest rate of 6%.
(3) Let i be a simple interest rate and suppose i6 = 0.04. Calculate i.
(4) A fund is earning 5% simple interest. If in = 0.04, calculate n.
(5) Suppose A(5) = $2, 500 and i = 0.05.
(a) What is A(7), assuming simple interest?
(b) What is a(10), assuming simple interest?
32
33
6 DATE CONVENTIONS UNDER SIMPLE INTEREST MACS 101
6 Date Conventions Under Simple Interest
Motivation: Thus far, the length of investment has been an integral number of years
(i.e., 2 years, 1.5 years, etc.).
• What if the time is given in days?
• In this section we discuss three techniques for counting number of days in a period
of investment between two values.
• In all three cases,

# of days between two dates
time = .
# of days in a year
• In all three cases, it is assumed (unless otherwise stated), that in counting days, inter-
est is not credited for both the starting date and the ending date, but for only one
of these days.
6.1 Exact Simple Interest
Definition: The following rules apply to the “exact” or “actual/actual” method:
• Count the exact number of days for the period of investment and use 365 days in a
non-leap year and 366 days for a leap year (a year divisible by 4).
• Simple interest computed with this method is called exact simple interest.
• It is important to know the number of days in each month.
• In counting days between two dates, the last date, but not the first date, is included.
Example 6.1. Suppose that $2,500 is deposited on March 8 and is withdrawn on October
3 of the same year. Also, suppose the interest rate is 5%. Find the amount of interest
earned, if it is computed using exact simple interest. Assume a non-leap year.
34
6.2 Ordinary Simple Interest
Definition: The following rules apply to the “ordinary” or “30/360” method:
• To make computations easier (i.e., before computers and calculators), we assume that
all months have 30 days, and all years have 360 days.
• Simple interest computed with this method is called ordinary simple interest.
• The ending date is counted and not the starting date (same as exact simple inter-
est).
• The Public Secretaries Association (PSA) publishes the following rules for cal-
culating the number of days between any two dates from M1 /D1 /Y1 to M2 /D2 /Y2 :
– If D1 (or D2 ) is 31, change D1 (or D2 ) to 30.
– If M1 (or M2 ) is 2, and D1 (or D2 ) is 28 (in a non-leap year) or 29, then change

D1 (or D2 ) to 30.
– The number of days, N , is:
N = 360(Y2 − Y1 ) + 30(M2 − M1 ) + (D2 − D1 ).
Example 6.2. Under these guidelines, what is the number of days from February 25 to
March 5 of the same year?
Example 6.3. Suppose Jack borrows $1,000 from the bank on January 28, 1996 at a rate
of 15% simple interest per year. How much does Jack owe on March 5, 1996? Use ordinary
simple interest.
35
6.3 Banker’s Rule
Definition: The following rules apply to the “Banker’s Rule” or the “actual/360” rule:
• Uses the exact number of days for the period of investment, where the calendar
year has 360 days.
• Simple interest computed with this method is called Banker’s rule.
• The number of days between two dates is found in the same way as for exact
simple interest.
• Once again, we count the last day, but not the first day.
Example 6.4. Suppose Jack borrows $1,000 from the bank on January 1, 1996 at a rate of
15% simple interest per year. How much does Jack owe on January 17, 1996? Use Banker’s
rule.
Remark: The methods discussed above also apply to compound interest rate prob-
lems (next chapter).
• Unless otherwise stated, in later sections we will assume the actual/actual method is
in use.
36
Problem Set 5
(1) If an investment was made on the date the United States entered World War 2, i.e.,
December 7, 1941, and was terminated at the end of the war on August 8, 1945, for
how many days was the money invested under:
(a) the “actual/actual” method?
(b) the “30/360” method?
(2) Comment: If the time is given in months, reduce it to a fraction of a year on the basis
of 12 months to the year, without changing to days.
A merchant is offered $50 discount for cash payment of a $1200 bill due in two months.
If he pays cash, at what rate may he consider his money to be earning interest in the
next two months?
(3) Find the amount of interest that $2,000 deposited on June 17 will earn, if the money is
withdrawn on September 10 in the same year (non-leap year) and if the simple rate of
interest is 8% using
(a) exact simple interest,
(b) ordinary simple interest, and
(c) Banker’s rule.
(4) The sum of $5,000 is invested on April 1 and withdrawn on June 30 (of the same year)
with 7% simple interest. Find the amount of interest earned
(a) assuming exact simple interest in a non-leap year;
(b) assuming exact simple interest in a leap year;
(c) assuming ordinary simple interest;
(d) assuming the Banker’s rule.
(5) Suppose you lend $60 to your sister on September 14, at an annual rate of simple interest
of 10%, to be repaid on December 25. How much does she have to pay you back? use
the actual/360 method.
37
38
39

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MACS 101

Introduction to Actuarial Science

Course Notes: The course notes are based on the Finan

Last Updated: January 5, 2019

2 The Meaning of Interest 7

3 Accumulation and Amount Functions 13

4 Effective Interest Rate 21

6 Date Conventions Under Simple Interest 34

1 Introduction to Actuarial Science

Note: Chapter 1 of the course notes is based on the following sources:

• “Be an Actuary” at beanactuary.org

• “Actuarial Outpost” at actuarialoutpost.com.

• “Society of Actuaries” at https://www.soa.org/Member/.

1.1 What is Actuarial Science?

(iii) People who study actuarial science are referred to as “actuaries.”

1.2 What do Actuaries Do?

(iv) From the Be an Actuary website: Actuaries are experts in

• “Evaluating the likelihood of future events-using numbers, not crystal balls”

• “Designing creative ways to reduce the likelihood of undesirable events.”

• “Decreasing the impact of undesirable events that do occur.”

(v) Video posted on the Be an Actuary website:

1.3 Why Actuarial Science?

(i) Video posted on the Be an Actuary website:

1.4 Accrediting Agencies

(i) Two US accrediting agencies:

• Casualty Actuarial Society (i.e., CAS)

• Society of Actuaries (i.e., SOA).

(ii) Actuaries are typically required to be accredited to one of these agencies.

1.4.1 Casualty Actuarial Society (CAS)

(i) Smaller of the two agencies.

(iii) “Shorter” insurance.

(iv) Only one track.

(v) Two designations:

(a) Associate of the CAS (ACAS)

(b) Fellow of the CAS (FCAS).

1.4.2 Society of Actuaries (SOA)

(i) Larger of the two agencies.

(iii) “Longer” insurance.

(a) Corporate Finance and ERM Track (i.e., CFE)

(b) Quantitative Finance and Invenstment Track (i.e., QFI)

(c) Individual Life and Annuities Track

(d) Retirement Benefits Track

(e) Group and Health Track

(f) General Insurance Track.

(v) More information about the different tracks:

(vi) Different exams are required for each track.

(vii) Two designations:

(a) Associate of the SOA (ASA)

(b) Fellow of the SOA (FSA).

1.5 Actuarial Exams

(ii) Can be taken in any order.

(v) Each is scored 0-10; 6 is a pass grade.

(vi) Offered every 2-6 months, depending on the exam.

(vii) Don’t get discouraged!

(viii) Exam study sources:

(a) Couching Actuaries at https://www.coachingactuaries.com/

(b) Infinite Actuary at https://www.theinfiniteactuary.com/

(c) Actuarial Study Materials at http://www.studymanuals.com/

(d) Other students who have passed!

(e) Real actuaries!

(x) Exam P is 3 hours and comprised of 30 questions.

(xi) Exam FM is 3 hours and comprised of 35 questions.