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Financial Math

An annuity is a series of regular cash payments made or received at fixed intervals. There are two types of annuities: ordinary annuities where payments are made at the end of each period, and annuities due where payments are made at the beginning of each period. When calculating the value of an annuity, two factors are considered: the timing of payments and the future and present value of cash flows. Compound interest calculates interest on both the principal and accumulated interest over time, while simple interest only calculates interest on the principal.

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35 views

Financial Math

An annuity is a series of regular cash payments made or received at fixed intervals. There are two types of annuities: ordinary annuities where payments are made at the end of each period, and annuities due where payments are made at the beginning of each period. When calculating the value of an annuity, two factors are considered: the timing of payments and the future and present value of cash flows. Compound interest calculates interest on both the principal and accumulated interest over time, while simple interest only calculates interest on the principal.

Uploaded by

muhammad atif
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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WHAT IS AN ANNUITY?

Annuities are a series of cash payments that are paid or received over time at regular
intervals. Annuities can have equal or different-amount payments, but they must
occur regularly. Perhaps the earliest annuity most people have experienced is the
school allowance. Then there are the apartment rentals, the cellphone staggered
payments, the lease payments on a car, etc. As long as there are recurring payments,
that may be considered an annuity.

There are two types of annuities: ordinary annuities and annuities due. Ordinary
annuities require payments at the end of each period previously determined and
agreed upon. A bond, for example, requires payments to the investor at the end of
every six months until the maturity date. The annuity due type of annuity has
payments given at the beginning of each period. A good example is rent for an
apartment or mortgage payments, which are commonly due at the beginning of each
month.

In coming up with a formula for the annuity, aside from inflation, two factors are
taken into consideration:

(1) the timing of the payment—whether it is paid at the beginning or at the end of the
period, and

(2) Future Value (FV) and Present Value (PV) perspectives.

THE FUTURE VALUE (FV) of a Single Sum of Cash Flow


The Future Value (FV) of a single sum of money is the future amount of money
invested today at a given interest rate (r) for a specified period. Denoted by FVN

The future value of a single sum of money is given by:

FVN = PV(1+r)N
Where

PV = present value of the investment


FVN = future value of the investment N periods from today
r = rate of interest per period
N=number of periods (Years)

EXAMPLE:

Calculating the Future Value


Suppose you deposited $5,000 in a savings account that earns an annual compound
interest of 7%, what would be the value of money in the savings account after ten
years?
Solution
From the question:

PV = 5,000
FVN =?
r =7%
N=10

⇒FVN= PV(1+r)N = 5000 (1+0.07)10 = 9,835.7568

COMPOUND INTEREST.

Compound interest is the interest calculated on the principal and the interest
accumulated over the previous period. It is different from simple interest, where
interest is not added to the principal while calculating the interest during the next
period. In Mathematics, compound interest is usually denoted by C.I.

Compound interest finds its usage in most of the transactions in the banking and
finance sectors and other areas. Some of its applications are:

1. Increase or decrease in population.


2. The growth of bacteria.
3. Rise or Depreciation in the value of an item.

SIMPLE INTEREST

Simple interest is a method to calculate the amount of interest charged on a sum at a


given rate and for a given period of time. In simple interest, the principal amount is
always the same, unlike compound interest where we add the interest to the principal
to find the principal for the new principal for the next year.

COMPOUND INTEREST

 A = amount
 P = principal
 R OR r = rate of interest
 n = number of times interest is compounded per year
 t = time (in years)
Alternatively, we can write the formula as given below:

CI = A – P

C.I = P ( 1+ R ⁄ 100) t – P
SIMPLE INTEREST

S.I = P x r x t/100

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