3.
1 Annuity
Definition of Terms
nnuity– a series of payments
A
TermoftheAnnuity–thetimefromthebeginningofthefirstpaymentperiodtotheendofthe
last payment period
Future Value of Annuity –the future dollar amount of a series of payments plus interest
PresentValueofanAnnuity–theamountofmoneyneededtoinvesttodayinordertoreceivea
stream of payments for a given number of years in the future
OrdinaryAnnuity–regulardeposits(payments)madeattheendoftheperiod,suchassalaries,
stocks, dividends, and so on.
Annuity Due – regular deposits (payment) made atthebeginningoftheperiod,suchasrentor
life insurance premiums.
3.2 Classification of Annuities
Contingent Annuities Annuities Certain
ave no fixed number of payments but
H Have a specific stated number of payments
depend on an uncertain event
Example: Life Insurance payments Example: Mortgage payments
egular deposits/payments made at the
R egular deposits/payments made at the
R
endof the period beginningof the period
J an. 31 onthly
M J an. 1
June 30 Quarterly April 1
Dec. 31 Semiannually July 1
Dec. 31 Annually Jan. 1
3.3 Calculating Future Value of an Ordinary Annuity by formula
Step 1: Calculate the number of periods, n, and rate per period, i.
Step 2: Determine the payment, PMT, given in the word problem.
Step 3: Plug these values into the future value of an ordinary annuity formula:
where
V = future value: the final amount of the loan or investment at the end of the last period
F
PMT = periodic payment amount
n=numberofcompoundingperiods:numberofyears*numberofcompoundingperiods
per year
i = interest rate per period: annual rate / number of compounding periods per year
olveforthefuturevaluebycalculatingwhat(1+i)^nisfirst.Subtract1fromthatnumberand
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thendividebyi.Multiplythisnumberbythepaymentamounttocalculatethefuturevalueofan
ordinary annuity.
3.4 Calculating Future Value of an Annuity Due by formula
Step 1: Calculate the number of periods, n, and rate per period, i.
Step 2: Determine the payment, PMT, given in the word problem.
Step 3: Plug these values into the Future Value of an Annuity Due Formula and solve:
where
V = future value: the final amount of the loan or investment at the end of the last period
F
PMT = periodic payment amount
n = number of compounding periods: no. of years * no. of compounding periods per year
i = interest rate per period: annual rate / number of compounding periods per year
alculatewhat(1+i)^nisfirst.Subtract1fromthatnumberandthendividebyi.Multiplythis
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number by the payment amount.
tep4:MultiplytheresultfromStep3by(1+i)toaccountforthebeginningoftheperiodand
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solve for the future value of an annuity due.
3.5 Calculating Future Value of an Annuity Due by formula
Step 1: Calculate the number of periods, n, and rate per period, i.
Step 2: Determine the payment, PMT, given in the word problem.
Step 3: Plug these values into the present value of an ordinary annuity formula:
where
V = present value:thevalue“today”ofanamount–todaybeingthepresentworthofa
P
future amount
PMT = periodic payment amount
n = number of compounding periods: no. of years * no. of compounding periods per year
i = interest rate per period: annual rate / number of compounding periods per year
alculate what (1 +i)^nisfirst.Divide1bythatanswerandthensubtractthatanswerfrom1.
C
Divide this by i. Multiply this number by the payment amount.
4.1 Sinking Funds
efinition of Terms
D
Sinking Fund – a financial agreement that sets aside regular periodicpaymentsofaparticular
amount of money.
ompound interest accumulates on these payments to a specific sum atapredeterminedfuture
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date. Corporations use sinking funds to discharge bonded indebtedness, to replace worn-out
equipment, to purchase plant expansion, and so on.
I n a sinking fund, you determine theamountofperiodicpaymentsyouneedtoachieveagiven
financial goal. In the annuity, you know the amount of each payment and must determine its
future value.
4.1 Calculating Sinking Funds Payment by formula: (Periodic Payments)
Step 1: Calculate the number of periods, n, and rate per period, i.
Step 2: Determine the payment, FVoa, given in the word problem.
Step 3: Calculate the payment using the following formula:
where
Voa = future value of an ordinary annuity (payments are made at the end of each period)
F
n = number of compounding periods: no. of years * no. of compounding periods per year
i = interest rate per period: annual rate / number of compounding periods per year
alculate what (1 + i)^n is first. Subtract 1 fromthatanswer.Storeit.MultiplytheFVoabyi.
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Divide this by your stored number.
