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Annuity Problems 2

An annuity is a financial instrument that provides periodic payments to the account holder. There are different types of annuities including ordinary annuities where payments are made at the end of each period, annuities due where payments are made at the beginning of each period, and deferred annuities where payments are delayed for a number of periods. Formulas can be used to calculate the future value, present value, and payments of these different types of annuities based on factors like the interest rate, payment amounts, and number of periods.

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Ali Salim Ali El-Busaidi
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2K views

Annuity Problems 2

An annuity is a financial instrument that provides periodic payments to the account holder. There are different types of annuities including ordinary annuities where payments are made at the end of each period, annuities due where payments are made at the beginning of each period, and deferred annuities where payments are delayed for a number of periods. Formulas can be used to calculate the future value, present value, and payments of these different types of annuities based on factors like the interest rate, payment amounts, and number of periods.

Uploaded by

Ali Salim Ali El-Busaidi
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
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Annuities

An annuity is a financial plan characterized by periodic payments/deposits. We can view an annuity as a savings plan in which the regular payments are contributions to the account, or we can also view an annuity as a payment plan in which regular payments are made from an account. Distinct formulas can be used to calculate the different types of annuities.

Future Value of an Ordinary Annuity:


If an amount R is deposited at the end of each period for n periods in an annuity that earns interest at a rate of i per period, then the future value of the annuity will be: n S = Future Value R = Payment

(1 + i ) 1 S = R i
i=x/y

i = Interest rate according to the period. Can be calculated by: n = total time period, calculated by:
Example:

n = t*y

x=Interest rate y=Period t=Time in years y=period

$200 is deposited at the end of each quarter in an account that pays 4%, compounded quarterly. How much money will we have in the account in 2 years and 3 months?

Solution:

n = (4)(2.25) = 9, i = 0.04 = 0.01 4

(1 + 0.01)9 1 S = 200 = $1873 .71 0 . 01

Future Value of an Annuity Due


If the payments/deposits of the annuity are given at the beginning of each time period, it is called an annuity due. The following formula calculates future value:

Sdue = Future Value R = Payment

S due

(1 + i )n 1 = R (1 + i ) i
i=x/y

i = Interest rate according to the period. Can be calculated by n = total time period, calculated by:
Example:

x=Interest rate y=Period t=Time in years y=period

n = t*y
(1 + .006 )108 1 S = 150 (1 + 0.006 ) = $22,836.59 0.006

Find the future value of an investment if $150 is deposited at the beginning of each month for 9 years and the interest rate is 7.2%, compounded monthly.

Solution:

R = $150, n = 9(12) = 108, i = 0.072 / 12 = 0.006

Present Value of an Ordinary Annuity


To calculate the present value of an ordinary annuity the following formula is used:

An = Present Value R = Payment

1 (1 + i ) n An = R i
i=x/y n = t*y
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i = Interest rate according to the period. Can be calculated by n = total time period, calculated by:
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x=Interest rate y=Period t=Time in years y=period

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Example:

What is the present value of an annuity of $1,500 payable at the end of each 6-month period for 2 years if money is worth 8%, compounded semiannually?

Solution:

R = $1,500, i = 0.08 / 2 = 0.04, n = (2)(2) = 4

1 (1 + 0.04 )4 An = 1500 = $5,444 .84 0 . 04

Present Value of an Annuity Due


To calculate the present value of an annuity due the following formula is used: A(n,due) = Present Value R = Payment

1 (1 + i ) n A(n ,due ) = R (1 + i ) i
i=x/y n = t*y

i = Interest rate according to the period. Can be calculated by n = total time period, calculated by:
Example:

x=Interest rate y=Period t=Time in years y=period

Suppose that a court settlement results in a $750,000 award. If this is invested at 9% compounded semiannually, how much will it provide at the beginning of each half-year for a period of 7 years?

Solution:

A(n,due ) = $750,000, n = 2(7) = 14, i = 0.09 / 2 = 0.045


R= $750,000 = $70,205.97 10.682852

1 (1 + 0.045 )14 $750,000 = R (1 + 0.045 ) 0.045

Deferred Annuity
A deferred annuity is characterized by a payment which is made at some later date, rather than the beginning or end of the time period. The following formula calculates the present value of the deferred annuity:

A(n,k) = Present Value R = Payment

1 (1 + i ) n k ( ) A(n ,k ) = R + i 1 i
i=x/y n = t*y

i = Interest rate according to the period. Can be calculated by n = total time period, calculated by: k = deferred periods
Example:

x=Interest rate y=Period t=Time in years y=period

A deferred annuity is purchased that will pay $10,000 per quarter for 15 years after being deferred for 5 years. If money is worth 6% compounded quarterly, what is the present value of this annuity?

Solution:

R = $10,000, n = 4(15) = 60, k = 4(5) = 20, i = 0.06 / 4 = 0.015 1 (1 + 0.015 )60 20 A(60 , 20 ) = 10,000 (1.015 ) = $292,386.85 0.015

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