LESSON III: ANNUITIES

Annuity: It means SERIES of EQUAL PAYMENTS occurring at EQUAL PERIOD or done at

EQUAL TIME INTERVALS.

FYI:

1. It can also be defined as a uniform series of payments made for a total of n interest periods.

2. To recognize it, just look for sets of equal payments being made, normally by buyer or borrower, at an
equal time interval, such as MONTHLY of YEARLY. Annuity contains MONETARY unit.

3. Annuities are established for the following purposes:

3.1. Borrower’s viewpoint: To extinguish a present debt by a series of equal payments made an equal
time interval.

NB: This annuity scheme is called AMORTIZATION.

3.2. Investor’s viewpoint: To accumulate a required amount in the future by depositing equal amount at
equal time intervals.

NB: This annuity scheme is called SINKING FUND.

3.3. Social insurance institution’s viewpoint: To replace a future lump-sum payment with equal
periodic payment such as PENSION.

4. Tabulation of quantities used in annuity analysis and calculations:

Symbol Meaning Unit

P Present Worth, Present Amount, Present Value of Money Pesos
F Future Worth, Future Amount, Future Value of Money Pesos
A A series of periodic, equal amount of money or annuity. Pesos
n Number of interest period year
i interest rate per interest period %

NB: When solving annuity problems, the number of interest period and interest rate per period must be
made COMPATIBLE.

5. Annuities are classified as ordinary annuity, annuity due, and differed annuity.

5.1. Ordinary Annuity: It is an annuity in which the payments are made at the END of each period.

N.B: For this annuity system, the number of interest period (n) EQUALS the number of annuities (A’s).
CFD of Ordinary Annuity: Reference = mathalino.com

5.2. Annuity Due: It is an annuity in which the first payment is made at the START of first period.

NB: Premiums which are equal payments made at the beginning of each period are considered annuity
dues.

CFD of Annuity Due: Reference = mathalino.com

5.3. Differed Annuity: It is an annuity in which the payments begin at some LATER DATE beyond the
first period.

CFD of Ordinary Annuity: Reference = mathalino.com

A. Ordinary Annuity Analysis and Calculations:
FYI:
1. An ordinary annuity is a series of equal payments made at the end of consecutive periods over a
fixed length of time. While the payments in an ordinary annuity can be made as frequently as every
week, in practice they are generally made monthly, quarterly, semi-annually, or annually.

2. Examples of ordinary annuities are interest payments from bonds, which are generally made semi-
annually, and quarterly dividends from a stock that has maintained stable pay out levels for years.

N.B: A bond is a fixed income instrument that represents a loan made by an investor to a
borrower (typically corporate or governmental). It is a debt security.

3. The present value of an ordinary annuity is largely dependent on the prevailing interest rate.

4. The FAQ or the quantities normally computed/solve in ordinary annuity problems are any of the
following:

4.1. F = Future Value [ Present value, interest rate, and interest period will be specified]

4.2. P = Present Value [ Future value, interest rate, and interest period will be specified]

4.3. i = interest rate [ Present value, Future value, and interest period will be specified]

4.4. n = interest period [ Present value, Future value, and interest rate will be specified]

4.5. A = annuity
Ordinary Annuity Formulas and Cash Flow Diagram:

Formula Functional Symbol

(𝟏+𝒊)𝒏 −𝟏
1. Formula to find F when A is specified: 𝑭=𝑨[ ] F = A (F/A, i%, n)
𝒊

Figure: Reference = pueblerino.com

N.B:

1.1. The quantity in the bracket is called uniform series compound amount factor.

1.2. The above formula is designated by a functional symbol F/A, i %, n, and read as “F given A at i
percent in n interest period”

𝟏− (𝟏+𝒊)−𝒏
2. Formula to find P when A is specified: 𝑷=𝑨[ ] P = A (P/A, i%, n)
𝒊

Figure: Reference = pueblerino.com

N.B:

2.1. The quantity in the bracket is called uniform series present worth factor.

2.2. The above formula is designated by a functional symbol P/A, i %, n, and read as “P given A at i
percent in n interest period”

𝒊
3. Formula to find A when F is specified: 𝑨 = 𝑭 [(𝟏+𝒊)𝒏 −𝟏] A = F (A/F, i%, n)

N.B:

3.1. The quantity in the bracket is called sinking fund factor.

3.2. The above formula is designated by a functional symbol A/F, i %, n, and read as “A given F at i
percent in n interest period”

𝒊
4. Formula to find A when P is specified: 𝑨 = 𝑷 [𝟏− (𝟏+𝒊)−𝒏 ] A = P (A/P, i%, n)

N.B:

4.1. The quantity in the bracket is called capital recovery factor.

4.2. The above formula is designated by a functional symbol A/P, i %, n, and read as “A given P at i
percent in n interest period”

Illustrative Problems

1. Couple’s Nilo and Malou Co want to put up a hopia factory for business. Luckily, they were able to
secure a P1M loan now from a bank charging 10 % effective rate of interest. They promised to pay the
loan annually for five years. Find the annual amortization to extinguish this obligation.

2. Vic Que, a 1st year engineering student is aiming to establish his own business at the end of his studies.
To do this, he must make a yearly deposit P20K to Banko de Ginto that offers an effective interest rate
of 5%. How much the accumulated fund be after his graduation if he completed his studies in exactly
five years?

3. Andres, in his desire to revive his KKK Foundation and help the victims of pandemic borrowed money
today from his best friend Emilio and promised to pay this loan in twelve equal quarterly payment of
P50000. Emilio charges an interest rate of 12% compounded quarterly. What is the amount of this loan
at the end of the interest period or at its terminal date?

4. Engr. Doug Mugas, an engineer at a big manufacturing company is planning to put up his own business
in the near future by depositing P50000 at the end of every three months for five years in Banko de
Tanso. The bank gives an interest rate of 10% compounded semi-annually. How much money does this
engineer accumulates at the terminal date?
Engr. Doug Mugas reaction at the terminal date:
5. Mr and Mrs Yu, proud parents of Vina, a newly licensed female engineer plans to surprise her by
giving brand new car. A sales agent offers them a model available on installment basis of P500K
downpayment and the remaining balance to be paid in monthly basis of P20000 good for five years at an
interest rate of 9% compounded monthly. What is the cash price of this car?

Vina’s reaction after receiving the brand-new car from her parents.

Figure Reference = tenor.com

B. Annuity Due Analysis and Calculations:

(𝟏+𝒊)𝒏+𝟏 −𝟏
1. Formula to find F when A is specified: 𝑭=𝑨[ ]
𝒊

(𝟏+𝒊)𝒏+𝟏 −𝟏
2. Formula to find P when A is specified: 𝑷=𝑨[ ]
𝒊(𝟏+𝒊)𝒏

N.B: The value of n is the time in which the last payment is due.

FYI: Example, if the annuity due is five annual equal payment good for five years, the value of
n = 4. WHY? Because the last payment or the 5th will occur at year 4. To understand it carefully,
draw the CFD!

Problems:

1. Engr. Val Yena. a first-time father, get an educational plan that will give P100000 to his son on his 18th
birthday. The company provides an interest rate of 10% compounded annually. If the first payment for
this plan is at the start of the first year, compute the yearly payment. Answer = P2193.02