102 Session 2

Calculate accumulated value

using δ(t)

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 Reminder:
“total force of interest”
If i is constant annual effective rate of interest, the accumulated
amount at time t is (1+i)^t

So we need 1 / (1+i)^t now to have 1 at time t

so the present value of 1 payable at time t is (1+i)^-t

Define δ as ln(1+i). So e δt = (1+i)^t

δt is the “total force of interest” from time 0 to time t.

So e^(total force of interest) = accumulated amount at time t

And present value of 1 payable at time t is

e ^-(total force of interest)
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0.05

Force of interest (green curve) goes

0.04
from approx .... to ....% (straight red
0.03 line) so average force of interest &
0.02
constant annual effective rate is approx
A = 0.005 t
.... Roll up by very roughly .....% pa to
0.01
A = 0.005t + 0.001t^2 estimate present value as very roughly
0 100* (1 + …%pa * 8 years) = £......
0 1 2 3 4 5 6 7 8

Total force of interest is exactly ∫ δ(t) dt = ∫ ........................ dt

= ...............................................
= ....................................
So present value = 100 * e^+(total force of interest)
= 100 * e^+................... = £......... (agrees rough check?)
Average force of interest = ................... / 8 = ...........%
So constant annual effective rate is e^............% - 1 = ..........% (agrees?) 70
0.05 Force of interest (green curve) goes
from approx 0 to 4% (straight red line)
0.04
so average force of interest & constant
0.03 annual effective rate is approx 2%. Roll
0.02
up by very roughly 2% pa to estimate
A = 0.005 t
present value as very roughly
0.01
A = 0.005t + 0.001t^2 100* (1 + 2% * 8) = £116.
0
0 1 2 3 4 5 6 7 8

Total force of interest is exactly ∫ δ(t) dt = ∫ 0.005t + 0.001t^2 dt

= 0.005/2 * 8^2 + 0.0001/3 * 8^3
= 0.17707.
So present value = e^+(total force of interest)
= 100 * e^+0.17707 = £119.37 (consistent with rough check)
Average force of interest = 0.17707 / 8 = 2.213%
So constant annual effective rate is e^2.213% - 1 = 2.238% (agrees) 71
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Specimen Q8 (i)

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8%
Force of interest (green curve) goes
7%
from exactly ....% to ....% so average
6%

5%
force of interest is approx ...% for first
4% payment and ....% for second. So roll
3% up by approx ...% * 10 = ...% for first
A = 0.05 + 0.001t + 0.0001t^2
2% investment and .... * 5 = .... for second.
1%
Total approx 100 * ..... + 100 * ..... = ....
0%
0 1 2 3 4 5 6 7 8 9 10

Total force of interest that applies to first investment is

exactly ∫ δ(t) dt = ∫ ................................................... dt
= .............................................................. = ..................
Total force of interest that applies to second investment is
exactly ∫ δ(t) dt = ∫ .....................................................dt
= ..................................................................................
= ..................................................................................
Accumulation factor = e^+(total force of interest) & accumulated amount
= 100 * e^.............. + 100 * e^............. = £......... (OK with rough check?) 74
8%
Force of interest (green curve) goes from
7%
exactly 5% to 7% so average force of
6%

5%
interest is approx 6% for first payment and
4% 6.5% for second.
3% Roll up by approx 6% * 10 = 60% for first
A = 0.05 + 0.001t + 0.0001t^2
2% investment and 6.5% * 5 = 33% for second.
1%
Total approx 100*1.60+100 * 1.33 = 293.
0%
0 1 2 3 4 5 6 7 8 9 10

Total force of interest that applies to first investment is

exactly ∫ δ(t) dt = ∫ 0.05 + 0.001t + 0.0001t^2 dt
= 0.05 * 10 + 0.001/2 * 10^2 + 0.0001/3 * 10^3 = 0.58333.
Total force of interest that applies to second investment is
exactly ∫ δ(t) dt = ∫ 0.05 + 0.001t + 0.0001t^2 dt
= 0.05 * (10 – 5) + 0.001/2 * (10^2 – 5^2) + 0.0001/3 * (10^3 – 5^3)
= 0.58333 – 0.26667 = 0.31667.
Accumulation factor = e^+(total force of interest) & accumulated amount
= 100 * e^0.58333 + 100 * e^0.31667 = £316.45 (OK with rough check) 75
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 9% Average force of interest is about ....%
8% from 0 to 6 then about ....% from t=6 to 12.
7%
100 * 6 = £...... cash is paid on average at t = ...
6%
So roll up by about ... for 3 years
5%
4%
and ... for 6 years = .... ^3 * .....^9.
3% ie accumulated amount is about
2% 600 * .......* ........ = £............
1%
0%
0 1 2 3 4 5 6 7 8 9 10 11 12

Total force of interest from time t to time 12

= force from t to 6 plus force from 6 to 12
= ( 6 – t ) * ...... + ∫ (6 to 12) ............................... dx
= ( 6 – t ) * .......+ ........................................
= ................... – .......... * t
Total accumulated amount = ∫ rate of payment * Accumulation factor dt
= ....... ∫ e^total force of interest dt = ...... * e^........ * ∫ e^(..... * t) dt 78
= ..................................................... (OK with rough check?)
 9% Average force of interest is about 6%
8% from 0 to 6 then about 7% from t=6 to 12.
7%
100 * 6 = £600 cash is paid on average at t = 3.
6%
So roll up by about 6% for 3 years
5%
4%
and 7% for 6 years = 1.06^3 * 1.07^9.
3% ie accumulated amount is about
2% 600 * 1.19 * 1.5 = £1,070
1%
0%
0 1 2 3 4 5 6 7 8 9 10 11 12

Total force of interest from time t to time 12

= force from t to 6 plus force from 6 to 12
= ( 6 – t ) * 6% + ∫ (6 to 12) 0.05 + 0.0002x^2 dx
= ( 6 – t ) * 6% + (12 – 6 ) * 0.05 + (12^3 – 6^3)/3 * 0.0002
= 0.7608 – 6% * t
Total accumulated amount = ∫ rate of payment * Accumulation factor dt
= 100 ∫ e^total force of interest dt = 100 * e^0.7608 * ∫ e^(6% * t) dt 79
= 213.999 * (1 – e^-.36)/0.06 = 1078.28 (OK with rough check)
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END of session 2

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