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8 views3 pages

Lec 06

Uploaded by

maramaselai942
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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ST3452: Actuarial Statistics National University of Lesotho

Lecture 6: February 12
Lecturer: T. Khalema

6.1 Varying Annuities

This lecture extends results developed in the last few lectures in which annuity payments were level. Here
we consider varying payments—first increasing and then decreasing.

6.1.1 Increasing Annuities

Annuities with increasing payments are generally referred to as increasing annuities. Simple increasing
annuities increase by a fixed amount each time. This is in contrast to compound increasing annuities which
increase by a common factor each time.

6.1.1.1 Payments in arrear

Consider a series of n payments such that the payment at time t is of amount t where t = 0, 1, . . . , n. This
is an increasing annuity paid in arrear. The present value of such an annuity is denoted

(Ia) n .

We have
(Ia) n = v + 2v 2 + 3v 3 + · · · + nv n . (6.1)

It can easily be proved that


ä n − nv n
(Ia) n = . (6.2)
i

Eq. 6.2 is worth memorising. The proof proceeds as follows: from Eq. 6.1 we have

(1 + i)(Ia) n = 1 + 2v + 3v 2 + · · · + nv n−1 . (6.3)

Subtracting Eq. 6.2 from Eq. 6.3 yields

i(Ia) n =1 + v + v 2 + · · · + v n−1 − nv n (6.4)


n
=ä n − nv , (6.5)

from which we easily obtain Eq. 6.2.


Note that (Ia) n i denotes the present value of a simple increasing annuity of first payment 1, second payment
2, third payment 3, etc. and last payment n, where the payments are made in arrear for n time periods and
valued at an effective rate of i per period.

6-1
6-2 Lecture 6: February 12

The present value of an annuity payable in arrear for n time periods for which the amounts of successive
payments form an arithmetic progression can be expressed in terms of a n and (Ia) n . Suppose that the first
payment of such an annuity is P , the second payment being P + Q, the third being P + 2Q and so on until
a total of n payments are made. Then the present value of such payments is

P V = P v + (P + Q)v 2 + (P + 2Q)v 3 + · · · + [P + (n − 1)Q]v n


which can easily be shown to simplify to

P V = (P − Q)a n + Q(Ia) n . (6.6)

Exercise 6.1 Find the present value as at 1 January 2005 of a series of payments of 10 annual payments
starting at M 100 on 1 January 2006 and increasing by M 100 each year. Assume an effective rate of interest
of 8% pa.

Solution: M 5, 952.72

6.1.1.2 Payments in advance

Consider a series of n payments such that the payment at time t is of amount t + 1 where t = 0, 1, . . . , n − 1.
This is a simple increasing annuity paid in advance or a simple increasing annuity due. Arithmetically we
have

(I ä) n = 1 + 2v + 3v 2 + · · · + nv n−1 . (6.7)

From Eq. 6.7 we have


v(I ä) n = v + 2v 2 + 3v 3 + · · · + nv n . (6.8)
Subtracting Eq. 6.8 from Eq. 6.7 gives

d(I ä) n =1 + v + v 2 + · · · + v n−1 − nv n (6.9)


n
=ä n − nv , (6.10)

from which we have

ä n − nv n
(I ä) n = . (6.11)
d
This is another equation worth memorising.
Note that (I ä) n i denotes the present value of a simple increasing annuity of first payment 1, second payment
2, third payment 3, etc. and last payment n, where the payments are made in advance for n time periods
and valued at an effective rate of i per period.

6.1.2 Decreasing annuities

A simple decreasing annuity is a series of payments that decrease by a fixed amount each time.
Lecture 6: February 12 6-3

6.1.2.1 Payments in arrear

Consider a series of n payments such that the first payment occurring at time 1 is of amount n, the second
payment occurring at time 2 is of amount n − 1 and so on until the last payment occurring at time n being
of amount 1. The present value of this annuity is denoted (Da) n . Arithmetically we have

(Da) n = nv + (n − 1)v 2 + (n − 2)v 3 + · · · + 2v n−1 + v n .

Exercise 6.2 Show that


n − an
(Da) n = .
i

6.1.2.2 Payments in advance

Next consider a series of n payments such that the first payment occurring at time 0 is of amount n, the
second payment occurring at time 1 is of amount n − 1 and so on until the last payment occurring at time
n − 1 being of amount 1. The present value of this annuity is denoted (Dä) n and is given by

(Dä) n = n + (n − 1)v + (n − 2)v 2 + · · · + 2v n−2 + v n−1 .

Exercise 6.3 Show that


n − an
(Dä) n = .
d

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