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IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Time value of money: compound interest and discounting

An investor is due to receive Rs 50,000 in 4 years' time. The effective annual rate of interest is 6%. What is the present value of this payment, to the nearest rupee?

The present value is about Rs 39,605. Discount the Rs 50,000 over four years at 6% effective annual interest by multiplying by 1.06 to the power minus four, which is 0.79209. Accumulating instead of discounting would wrongly give about Rs 63,124.

  1. ARs 39,605Correct
  2. BRs 40,000
  3. CRs 37,500
  4. DRs 63,124
  5. Rs 39,000

Explanation

PV = 50,000 × 1.06^-4. 1.06^4 = 1.262477, so PV = 50,000 / 1.262477 = 39,604.7, which is about Rs 39,605. Rs 63,124 results from accumulating instead of discounting. Rs 40,000 uses a rough simple-interest style adjustment.

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