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Chapter 3 FM

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13 views2 pages

Chapter 3 FM

Uploaded by

demeketeme2013
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FUTURE VALUE OF AN ANNUITY

An annuity is a series of equal payments made at fixed intervals for a specified number of
periods. For example, $100 at the end of each of the next three years is a three-year annuity. The
payments can occur at either the beginning or the end of each period. If the payments occur at
the end of each period, as they typically do, the annuity is called an ordinary, or deferred,
annuity. Payments on mortgages, car loans, and student loans are typically set up as ordinary
annuities. If payments are made at the beginning of each period, the annuity is an annuity due.
Rental payments for an apartment, life insurance premiums, and lottery payoffs are typically set
up as annuities due.
ORDINARY ANNUITIES
An ordinary, or deferred, annuity consists of a series of equal payments made at the end of each
period. If you deposit $100 at the end of each year for three years in a savings account that pays
5 percent interest per year, how much will you have at the end of three years?

By using the above formula the answer is 315.25

ANNUITIES DUE
Had the three $100 payments in the previous example been made at the beginning of each year,
the annuity would have been an annuity due. On the time line, each payment would be shifted to
the left one year; therefore, each payment would be compounded for one extra year.

Fn = A [(1+i) n-1 ] X (1+i)


I
If we take the same example, the future value of each cash flow is found, and those FVs are
summed to find the FV of the annuity due. The payments occur earlier, so more interest is
earned. Therefore, the future value of the annuity due is larger—$331.01 versus $315.25 for the
ordinary annuity.

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