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Simple Case Annuities

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8 views5 pages

Simple Case Annuities

Uploaded by

Archielyn Sasil
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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SIMPLE CASE FOR ANNUITIES

I. Introduction to Annuities
 Definition of Annuities
o A series of equal payments made at regular intervals over a
specified period of time.
o Examples: monthly rent, car payments, retirement payouts.
 Types of Annuities
o Ordinary Annuity: Payments are made at the end of each
period.
o Annuity Due: Payments are made at the beginning of each
period.
o Focus on the "Simple Case" where interest rates remain constant
and payments are uniform.
II. Present Value of Annuities
 Definition
o The present value (PV) of an annuity represents the total value of
all future payments, discounted to their value today.
 Formula for Present Value of an Ordinary Annuity

o P: Payment per period


o r: Interest rate per period
o n: Number of periods
 Formula for Present Value of an Annuity Due

o Extra factor of 1+r accounts for payments being made at the


start of each period.
III. Future Value of Annuities
 Definition
o The future value (FV) of an annuity is the amount that all the
payments will accumulate to, assuming the payments are
invested at a constant interest rate.
 Formula for Future Value of an Ordinary Annuity

o P: Payment per period


o r: Interest rate per period
o n: Number of periods
 Formula for Future Value of an Annuity Due

 IV. Key Differences Between Ordinary Annuity and Annuity Due


 Timing of Payments
o Ordinary Annuity: End of each period.
o Annuity Due: Beginning of each period.
 Effect on Value
o Payments made earlier (Annuity Due) result in higher future and
present values due to the extra period of interest increase.
V. Application of Annuities in Real Life
 Mortgages and Loans
o How mortgage payments follow the annuity structure, with the
value of the loan being the present value of future payments.
 Savings and Retirement Planning
o Using annuities to calculate how much money must be saved
each period to reach a retirement goal.
 Pensions
o Present value of an annuity calculation for pension plans,
determining the lump sum equivalent of a series of future
payments.
VI. Worked Examples
 Example 1: Calculating the Present Value of an Ordinary
Annuity
o Given a payment amount, interest rate, and number of periods,
compute the PV of an ordinary annuity.
 Example 2: Calculating the Future Value of an Annuity Due
o Using the formula, compute the FV of an annuity due, given the
required inputs.
VII. Conclusion
 Summary
o Simple annuities offer a useful financial structure for
understanding loans, savings, and investment plans.
o Knowing how to calculate present and future values allows better
financial decision-making.
 Further Considerations
o Extensions into more complex annuities (varying payments,
varying interest rates).

DEFERRED ANNUITY
I. Introduction to Deferred Annuity
 Definition: An annuity where payments or income begin after a set
deferral period.
 Types:
o Fixed Deferred Annuity: Pays a fixed interest rate.
o Variable Deferred Annuity: Payments vary based on
underlying investments.
II. Present Value of a Deferred Annuity
 Definition: The value today of future annuity payments that start after
a delay.
 Formula for Present Value of Deferred Annuity:

o P: Payment per period


o r: Interest rate per period
o n: Number of periods the annuity will be paid
o t: Number of deferred periods before payments start
III. Future Value of a Deferred Annuity
 Definition: The amount accumulated by the time payments start after
the deferral period.
 Formula for Future Value of Deferred Annuity:

o Variables as defined above.


IV. Conclusion
 Deferred annuities allow for growth before payments begin, useful in
long-term financial planning, such as retirement savings.

EXERCISES:
1. You take out a loan that requires you to make annual payments of $5,000
at the end of each year for the next 6 years. The interest rate on the loan is
4% per year. What is the present value of the loan?
2. You plan to pay monthly rent of $1,200 for the next 3 years. If the interest
rate is 5% per year, compounded monthly, what is the present value of the
total rent payments, assuming the payments are made at the beginning of
each month (Annuity Due)?
3. John plans to contribute $500 every quarter to a retirement account that
earns 8% annual interest, compounded quarterly. If he continues this for 10
years, what will be the future value of his retirement account at the end of
10 years?
4. Maria plans to go on a vacation in 5 years and wants to save for it by
depositing $1,000 at the beginning of each year into an account that earns
6% annual interest. What will be the future value of her savings after 5
years?
5. Michael wants to set up a college fund for his daughter by contributing
$3,000 at the end of each year into a deferred annuity that earns 5%
interest per year. He plans to start the contributions after a deferral period
of 4 years and will make contributions for a total of 6 years. What will be
the future value of the college fund when the last payment is made?

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