This document discusses the time value of money concept which is fundamental to actuarial science. It covers key topics like time preference, productivity of capital, and how uncertainty affects interest rates. Actuaries use time value of money to calculate present values which form the building blocks of actuarial models. They also apply this concept in insurance, which involves long term investment contracts, and other areas of finance. The next activity is to prepare a synopsis of a case study report on group life insurance to submit at the next Board of Directors meeting.

1. Time Value
of Money

2. Session AgendaSession Agenda
• IntroductionIntroduction
• Time PreferenceTime Preference
• Productivity of CapitalProductivity of Capital
• Uncertain FutureUncertain Future
• Level of Interest ratesLevel of Interest rates
• The Actuarial relationship to theThe Actuarial relationship to the
Time Value of Money.Time Value of Money.

3. IntroductionIntroduction
• The time value of money a fundamentalThe time value of money a fundamental
concept of actuarial science.concept of actuarial science.
• Actuaries use this concept, together withActuaries use this concept, together with
the concept of probability, in thethe concept of probability, in the
calculation of actuarial present values –calculation of actuarial present values –
which in tern becomes the buildingwhich in tern becomes the building
blocks of actuarial models.blocks of actuarial models.
• Two theories of time value of moneyTwo theories of time value of money
• Time PreferenceTime Preference
• Productivity of CapitalProductivity of Capital

4. Time PreferenceTime Preference
• People need and use moneyPeople need and use money
• For current livingFor current living
• For life styleFor life style
• For future needsFor future needs
• Also for protectionAlso for protection
• Present value of money=present value of goodsPresent value of money=present value of goods
• Borrowing from future is done becauseBorrowing from future is done because
• To satisfy current needsTo satisfy current needs
• To plan for futureTo plan for future
– Hence, future money can satisfy Current/PresentHence, future money can satisfy Current/Present
needs only if they can be pledged, borrowed againstneeds only if they can be pledged, borrowed against
or otherwise moved from future into present.or otherwise moved from future into present.

5. Productivity of CapitalProductivity of Capital
• The strong preference for present money may be adequateThe strong preference for present money may be adequate
in itself to explain consumer borrowing and consumerin itself to explain consumer borrowing and consumer
lending.lending.
• Business small or large require capital goods to prosper.Business small or large require capital goods to prosper.
• The retailer’s place of business and inventory, and theThe retailer’s place of business and inventory, and the
farmer’s seed, fertilizer, and machinery represent the capitalfarmer’s seed, fertilizer, and machinery represent the capital
goods which, combined with labor, produce business income.goods which, combined with labor, produce business income.
• In long run a business will be successful only if the ROCIn long run a business will be successful only if the ROC
employed is greater than the rate of Interest.employed is greater than the rate of Interest.
• Time value of money is often measured by the income thatTime value of money is often measured by the income that
capital can produce, including business profits, dividends oncapital can produce, including business profits, dividends on
common stock, and other forms of investment income notcommon stock, and other forms of investment income not

6. Uncertain FutureUncertain Future
• Time preferences are affected by inability to see the futureTime preferences are affected by inability to see the future
clearly.clearly.
• Interest rates are expected to rise when uncertainty is high.Interest rates are expected to rise when uncertainty is high.
• Fears of inflation, the possibility of war, worries about tradeFears of inflation, the possibility of war, worries about trade
deficits or the value of the currency, are all conducive todeficits or the value of the currency, are all conducive to
increasing uncertainty, and to a higher price for presentincreasing uncertainty, and to a higher price for present
money.money.

7. Level of Interest ratesLevel of Interest rates
• For an analysis of interest rateFor an analysis of interest rate
behaviour, monitory considerationsbehaviour, monitory considerations
should be taken into account.should be taken into account.
• It is commonly held that the price ofIt is commonly held that the price of
money, like the price of other goodsmoney, like the price of other goods
varies with supply and demand.varies with supply and demand.

8. The Actuarial relationship toThe Actuarial relationship to
the Time Value of Moneythe Time Value of Money
• Like any person involved in business,Like any person involved in business,
economics, or finance, the actuary useseconomics, or finance, the actuary uses
the time value of money concept in histhe time value of money concept in his
daily work. There are two reasons for it.daily work. There are two reasons for it.
– First, because they are appliedFirst, because they are applied
mathematiciansmathematicians
– Financial system is the key area for themFinancial system is the key area for them
– Insurance is a long term investment contractInsurance is a long term investment contract
– There are also short term contractsThere are also short term contracts

9. ThankThank
YouYou
Activity for the next session???Activity for the next session???

10. • Prepare synopsis of the case to bePrepare synopsis of the case to be
discussed. REPORT OF ‘SOA’ ONdiscussed. REPORT OF ‘SOA’ ON
GROUP LIFE – Submit on 4GROUP LIFE – Submit on 4thth
of August’08of August’08
at BOD.at BOD.
Activity for the next session???Activity for the next session???