ANN UITY

1.
~ing and Definition of Annuity
An annuity is a fixed sum paid at regular intervals of time and a series of
a fixed amount of money paid at equal intervals of time under certain
conditions. For example,
Insurance instalments, payment ofloan in instalments, the paymen of the
price of goods purchased on instalments, hire -purchase instalmen saving
for sinking fund, awarding scholarship etc .
The interval oftime may either a year, or a half year or a quarter ye
or month etc. Ifnothing is mentioned about the interval oftime, it is alwa
taken as one year.
Types orHJnds of Annuity
(A) Based on Number flfJntervals of Time :
(1) Annuity Certain: A ann uity pay able for a fixed number of years
( any interval of time) is called Annuity Certam .
(2) Perpetual Annuity or Perpetuity : If an an nui is to con tinue fi ever,
it is called Annuity Perpetual or Perpetuity.
- (3)Annuity Contingent : An annuity which is pa ya.ble ..till the ha enin ~
of..!!!l event is calledAn .n.uit,}! Co~nt . For examp le, into tire marriage a
clii1d nm, upto the death of a person, upto the completion of education 0 the
children, etc.
H the payments are made till the death of a person, the annuity is
called Life Annuity . Life Annuity is an example of Annuity Contingent.
(4) Deferred Annuity : An annuity which is payable after a lapse of a
number of intervals oftime, is known as Deferred Annuity . In other words
if the payments of an annuity are deferred (i.e., delayed) for a certain
number of intervals of time (i.e. periods ), then it is known as deferred
annuity. When an annuity is deferred for d years, it is said to commence
after d years.
(B) Based on the time of payment in the Interval of Time:
(1) Immediate Annuity: If the payment of annuit is ma d at the en of
each interval ofti e, the annuity is called Immediate Annuity or lmply
AnnUL y mce 1 nothing is mentioned, then the annuity is considered as
immediate annuity.
(2) Annuity Due: Ifthe payment of uity is made at the begin ning
of each interval of time, then annuity is called nnzaty ue.
(C) As a mixture of the above types of Annuity we have the following
kinds of annuity:
(1) Certain Annuity Immediate: An annuity in which the payments are ~- made at
the end of each time of interval for a fixed time, is known as certain annuity
immediate.
(2) Certain Annuity Due : An annuity in which the payments are made at
the beginning of each time interval for a fixed time is known as certain
annuity due. ( <..
(vii) Present V alue of D eferred Perpet uity for d year s: l' a
p= -- .-
(1 + i)d i
~UNT OF IM;MEDIATE ANNUITY
ANNUITYCERTAIN
Let, (i) The periodic pa~~ts-b e ua insize, a = each p ayment. (ii) Each
payment
(3) Deferred is maAnnuit
Certain de a t the en of ea chCertain
y Immediate: time i erval.
annui ty imme diate
commence
(iii) The paymen after coincide
t periods d years, say is known
WI the interestas conver
deferred
sion certain an. n ._ ;ate.
periods
(iv) The inter
Deferred est ofRAnnuit
Certain e. 1 per period
y Due = i. annuity due whi ence after
: Certain
d(v)
years,
Thesanumber
y, is known as deferred
of equal payments certain
= no.annuity
of convedu rsion
e. p eriod
5) Certain Annuit y Continge nt: Certain annuity =n. which depend s 0 me
event
The timeis known
for th as
e beginnin
certain annuity
g ofthe conting
first payment
ent. period to th e end oft
last period(6) iDeferred
s called term ofthe annuity
Perpetuity : The ann. uity which will commence aft er d ars,
Sincand
say, e payment is m ade
the payments aftcontinue
will er the time forperiod
ev er, is known as deferred
. petuity.
=> First amount , Al = a (1 + it - 1, for tn - 1) periods .
Deferred
(7)Second Annuity Immediate: When an annuity
am ount, A2 = a (1 + i)" - 2, for (n - 2) periods is d eferred f or d ars
and the fi rst payment is made at the end of (d + I)th year, then i t .
ailed deferred.
(8) Deferred Annuity Due: When an annui ty is deferred for d years and . e first
. .
payment is mad e at the beginning of(d + I)th year, then it is called {erred
tn. - Dth
annuity due.amount, An _ 1 = a (1 + z), for i peri od.
FinalRelated
erms pa ymentwithwill be at the end of nth p eriod and there s hall be
Annuity
interest 1.onInstalment
it. of Annuit y or Annuit y: The pa yment made at ea erval
Hence
oftimenth amount,
is called An = a ent of annuity .
the instalm
2. Amount of Annuity: The s um of a ll insta lments w ith in1;s:res t due - e
Thus,
end of amount
The a givenof period is knoannuity
immediate wn as t he amount of an annuity. This i s
certain
called the Accumulat ed Sum of an Annuity
A = a (1 + it - 1 + a (1 . + it - 2 + ........+ a (1 + i) +
3. Present Value of an Annuit y. The sum of the present values of a ll
a yments (or instalm ents) is call ed the present value of an annuity . In other
ords, the present value = aof+the
a (1amo+ i)unt
+ ........+ a (1 +isi)"the
of an annuity + a (1 +value
-1present i)" • t hat
annuit y. a [(1 + i)" - 1] (i + A G eoma tric Progr ession
terms whose f irst term .
Lain Symbols and F ormula Based 1) - 1 on Compound andInterest
common r atio is (1 +
A = Amount of an A nnuity
P = Present Val ue of a n Annuity
a = Annuity or Instalmen t of an A nnuity i =
Interest of R upee one in a year, say n =
Number of yea rs (or time i ntervals)
(i) Amoun t of Certain Annuit y Immediate:
A= ~ leI + it - 11 or A = P(I + i)"
L

(ii) Present v ue Certain Annuity Due:

0
A
&.o-'\~or~
•....... \ ~ - T {1.J (1 + I)"-(1
- 1 }o r-
1-1. - \~ T ., L + i)"
(iii) Amount ofCertain Annuity D ue
A = a(I.+ i ){(I + i)" - II
L
(iv) Present Value of Certain A nnuity D ue
P = a(I.+ i){I _ (1 + ifn) or a(I.+ i ) {I __ I_}
L L (1 + i)"

. 1 a[ 1]
(v) Present Value of Def erred Certain Annu ity for d years:

:P = (1 + i)d. i 1 - (1 + it ;'
(vi) Present Valu e of
3.
2.
4.
5.
Perpetui ty :
PRESENT VALUE OF IMMEDIATE
ANNUITY CERTAIN
Let, (i) The periodic payments b e equal in siz e, a = each payment. (ii) Each
payme nt is made a t the end of each time per iod.
(iii) The p ayment periods coincide w ith the interest conversion p eriods.
(iv). The in terest ofR e. 1 for pe riod = i.
(v) The number of equal payment = no. of conversion period = n. ince
the pa yment is made at the end of each p eriod,
Hence, Present va lue of the first payme nt = ~1 . = a (1 + if 1 +L
Pres ent value of the s econd p ayment = ~ = a (1 + if 2 (1 + L)
Present value of the nth payment = __ a_ = a (1 + if '~ (1 + i)"
equired present va lue,
P = a (1 + if 1 + a (1 + if 2 + .... a (1 + if '"
= a (1 + if n + ......+ a (1 + if 2 + a (1 + if 1
 = (1 ')- n [(1 + i)" - 1]
a+L (1 + i) _ 1
= ~ [1 - (1 + if ILl or ~ [1 __ 1_]

_: =- __ tiue Method L

A = ~ [( I + i)" - I]
L (1 + i)"
...
(1)
L
6. __ __ -~- ... o."'-"''''J ..•.. ••• o.; ; Il •.&; .I,4JVV

PRESENT VALUE OF IMMEDIATE ANNUITY CERTAIN

When the annual instalment a is split into k parts and paym ent
is m
k times in a yea r (each ins talment is ~ ). Th e interest is also
compound tim es.
 \.L.VZJj

AMOUNT OF IMMEDIATE ANNUITY CERTAIN

en the period of payment and conversion period does not coincide] Case
1. When interest is compounded m times in a paymen t period, e.g.: (i)
Interest is compounded m times in a year, but the payment period is 1
year.
rii) Interest is co mpound ed quarterly, but the pa yment is made half
yearl y.
iii) Interest is compounded half-yearly , but the payment is made
annuall y.
In brief,
When the in terest is compound ed m times in a payment p eriod, then

[
(1 + rr: -1 ]
Amount ,A=a
(1 + i)m - 1
where i = Interest
per rupee for conversion period n = No. of
payments
m = Number of times, interest is convert ed in a paym ent perio d
7.
= Rs. 12,880 I
ase 2. When insta lroents are pai d k times a yea r but
interest is
unded annually, then
,~ A == ak[(1 + i)" - 1], i = per rup ee per yea r
I
9.
8.
 10.
11.
o iT OF AN ANNUITY INCREASING IN ARlTHl.VIETIC PROGRESSIO Let t he
annui ty be for n years.
The firs t paym ent of the annuit y is P and increases with a comm
difference Q, i.e.,
The pay ments are P, P + Q, P + 2Q, ............P + (n - 1) Q respectively.
Amount of th e first payment, S 1 = P (1 + it - 1 Amount of
the second pa yment, S2 = (P + Q) (1 + i)',-2 Amount of the
third payme nt, S3 = (P + 2Q) (1 + i)"-3
Amount of th e nth pa yment Sit = [P + (n - 1) Ql (1 + i)o
Total Amount = S
or S = Sl + S2 + S3 + ...........+ Sit
or S = P (1 + it - 1 + (P + Q) (1 + i)" - 2 + (p + 2Q) (1 + i)" - 3
+ ...........+ [(P + (n - 1)
or S = Pr"" 1 + (P + Q) r" - 2 (P + 2Q) r" - 3 + .............+ [P + (n - 1)
where r = \1. + ii > 1.
Multiplying both sides by r,
rS = Pr" + (P + Q) r" -1 + (P + 2Q) r" - 2 + .............+ [P + (n - 1) Ql r
Subtracti ng,
rS - S = Pr" + Qr" - 1 + Qr" - 2 + ...........+ Qr - [P + (n - 1) Ql
S (r - 1) = Pr" + Q lr" -1 + r" - 2 + ........+ r] - [P + (n - 1) Q]

or S (r - 1) = Pr" + Q
. [r (rlt - -1)]
1
- [P + (n - 1) Ql
r-l ,
S _ Prn_ ~ + Qrn - 1_ P ~ (n - 1) Q
r - 1 (r - 1)2 (r - 1)2/ r-1

i.e., S = P (1 + i)"_ Q (1 + i) + Q (1 + i)" -1 P + (n - 1) Q

(1 + L - 1) ( 1 + i - 1)2 ( 1 + i - 1)2 (1 + i-I)
=f (1 + i)" - Q(1 + i) + Q(1 + 1)" - 1_ P + (n - 1) Q
L i2 i2 _..-_

_ IOUNT AND PRESENT VALUE OF CERTAIN

ANNUITY DUE Let equal payments = a, Time
periods = n
i = per rupee per period ,
rate of int erest Each payment is made at the
beginning o f the p eriod.

Period which
Instalment Amount Present Value
earns interest
a n a (1 + i)" a
a n-l a(l+i)II-1 a
1+ i

a 1 a(l+i) a
(l+iY'-1

_~ amount of annity d ue is the sum o f money af ter a year o f payment

talment.
ount,A =a (1 + i)" +a(l + i)"-l + ...................+a (1 + i)
= a (1 + i) + ..............+ a (1 + i)" -1 + a (1 + i)"
j
= a (1 + i) [(1 + it - 1] Geometic progr ession of n terms)
(1 + i) - 1 whos e first term is a(l + i) and
(1+ .) comm _on ratio is (1 + i).
=a i 1 [(ltir-1]
a a
__ sent Value, PV = a + -(1 .) + ............+ 1
+L (1 + it
 a[l-IhnJ

1 __
( 1- 1 + i

= a (1 . + i) [1 _ _ 1_]
z (1 + it
 4 x 1.0816 ---- ---~
AMOUNT OF CERTAIN ANNUITY DUE
(When period of payment does not coin cide with conversion period )
Let the interest be compounded m times in a conversion period;
If payment = a, i = per rup ee per conversion period
m = no. of con version periods in period o f payments n
= no. of payments
nm = no. of conversion periods, Then amoun t
of first payment = a (1 + i) '111t Amount of
second payment = a (1 + i)"'"

Amount of nth payment = a (1 + i)'"

Amount , A = a (1 + i)""' + a (1 + i)(11 - 1)m + .. _ ........+ a (1 +
= a (1 + i)1II + ........+ a (1 + i)"1 1 1
=a ( 1+ [( f++it'" - 1]
i)'"
(1 i)'" - 1
12.
UN T AND PRESENT VALUE OF A DEFERRED ANNUITY
uity for (d + n) years w ith equal payment MRs. a is not
paid upto __ ::.. •••..••. the first pay ment is mad e after (d +
l)th year, th en its amount annuity certain
A = T [ (1 + it - 1]
.. n = no. of payment p eriods
resent value of deferred annuity is obtained as follo ws:
.. payment after (d + 1) years and tot al payment are n, then
. 1 a
Its present va ue = .d+1
(1 + L )
-u. ...••.arly
a
ent value of second pa yment = .d+2
,, (1
, + L)
, ,,
: :a
Present v alue of ' nth
payment =:
(1 + i) It
d+

.:e~ red Present Value,

a a a
p= (l+i)d+l+ (l+i)d+2+ .. · .... · ..·+ (l+i/+I!
= ~ [(1 + if 1+ (1 + if 2+ .........+ (1 + if It ]
(1 + ~)

= (l:i)d[(I+iflg=~~:!~~:)]

(1
a r( 1
+ if 1
+ i)d L( 1 + if
{I -+ +( if1
1 (1 i) - 1
It} ]=
 13. Funds
sinking fund is a fi xed amount of money deposited
periodically which ith compound int erest in ord er to meet som e
future liability. Fo r , liquida tion of a loan, a debenture stock,
for replacing a machin e
eeting the educa tion
expenses, etc . _reo"i ation
en articles are used , their cost is reduced. This reduction is
known iation. After some time these articles become usel ess
and there
, a scrap. The users of such articles save regularly to
replac .e these .' a new on e. Depreci ation ma y be calculated in two ways:
 (i) Fixed Depreciation Method
[Computed each year on the original cost] (ii)
Compound Depreciation Method [Computed
each year on the reduced cost]
Let the cost of a machine b e Rs. 15,000 and its expected life be 12
and its scrap costs Rs. 600. Ctf hi C f
.. os 0 a mac me - ost 0
T en e epreciation per year = E d lif .
xpecte ne m years
15,000 - 600
12
= l~i~OO = Rs. 1,200
.. 1200 x100
and fi xed depreciation perc ent = ' 15,000 = 8 per year
that is fix ed depreciation = 8% per year .
Compound Depreciation Method
Let the cost of the machine be Rs. 40,000 and rate of deprecia ti 10%
per annum
.. 40000 x 10
Depreciation offir st year = ' 100 = Rs. 4,000
Remaining Cost = 40,000 - 4,000 = Rs. 36,000
.. 36000 x 10
Depreciation of second year = ' 100 = Rs. 3,600
Remaining Cost = 36,000 - 3,600 = Rs. 32,400
Similarly Remaining Cost after nth year = 40,000 r 1 - 110 0 T
0
 -- _ ••.• f'"
.-- __ ~ ~- _ ~ , ..~~U """<t uew macmne: [Ans. Rs. 5,959.8
VALUATION OF SIMPLE LOAN AND DEBENTURE
Now-a -days, an individual borrows mone y (takes loan ) for constructing
a hous e, purchasing domestic articles, etc. Th e repa yment of lo an can be done
at various int erest rates and instalments. The per son have to decide which
conditi ons ofloan are profitable to him. That is on which condition th e interest
is Jess. In -other words, the terms and condition s for which the effective rat e
of interest is lowest will be profit able to the borrow er.
14.
If the loan is repai d in instalments, then the preferenc e is given on the si of p resent
values . The s pecific rate o f interest on whi ch the future ue or amount is less is preferab le
in the i nterest o f the borro wer.
Thus, we ca n say that by 'Valuation of si mple loan'we mea n compa rison -arious int erest
rates.
Some companies, in stitu tions or banks o r firms b orrow money f rom
lie and give them debe nture whose payment is done after a s pecified iod with int erest or
it is converted into shares. By 'Valuation a de benture' mean computation of its prese nt
value com pariso n with other ntures .