Contents

Number Title Page No.

1 Introduction 2

2 Simple Interest 2

3 Compound Interest 5

4 Nominal and Effective Rate of Interest 9

5 Annuity 10

6 Derivations of Different types of Annuities 11

7 Business Problems 18

8 Conclusion 24

1
 “Mathematics of Finance”

Introduction

In this chapter we shall focus on the use of financial information as a part of decision-making
process and shall introduce a number of techniques applied specifically to the evaluation of such
information. This leads into an examination of the principles involved in assessing the value of
money over a period of time.

Interest

Interest is the money that is paid for the use of money. The total amount of money borrowed
initially is called the principal amount. It might be an amount borrowed by an individual from a
Dank in the form of a loan, or by a bank from an individual in the form of a savings account. The
rate of interest is the amount charged for the use of the principal for a given period of time
(usually on a yearly basis). Rates of interest are generally expressed as a percentage.

Simple Interest

Simple interest is the interest computed on the principal for the entire period it is borrowed. If a
principal of P rupees is borrowed at a simple interest rate of r% per year for a period of t years,
then the simple interest is determined by:

S.I=Principal × Rate × Time = Prt

Thus, the amount A due to be paid at the end of the period of t years is:

A = Principal + Interest = P +Prt = P(1+rt) or P = A/1+rt

2
If we move backward, then this formula is used to calculate the value of the money.

Remark: The simple interest is charged on yearly basis. But if the time period is given in months,
weeks or days, the conversion formula is as given below:

k months= k /12

n years

n weeks=n/52 years (1 years = 52 weeks).

Illustration-01

A man deposited Tk. 5000 in a bank that pays 5% per annum every six month The man
will withdraw Tk. 500 from his principal plus any interest accrued at each six-month
period. How much total interest can he expect to receive?

Solution: In this case bank is borrowing Tk. 5000 at 5% interest and will pay off its debt in six
months. The interest to be paid for first six months. The interest to be paid for first six months
period in

I= 5000(1/2) (0.05) =Tk.125

2nd installment, I = 4500(1/2) (0.05) = Tk.112.50

3rd installment, I = 4000(1/2) (0.05) = Tk.100.00

.................................................................................

3
10th installment, I = 500(1/2) (0/05) = Tk. 12.50 Total interest paid by the bank (received by the
man) is

= 125.00+112.50 +100.00+. +25.00+12.50

= 12.50 +12.50(2) +12.50(3) +.......+(12.50) (10)

= 12.50(1+2+3+………+10)

= 12.50x 10(10+1)/2= Tk.687.50 [Sum of first n natural numbers=n(n+1)/2]

Illustration-02

A person desires to buy a house. If the person borrowed Tk. 4 lakhs at 12% interest for 36
months, find the simple interest the person paid the first month and the portion of the
house purchased with the first payment of Tk. 50,000.

Solution: P = TK.4,00,000, r = 12% and t=1/12. Using the formula, I = Prt, we get

I=4000000×12/100×1/12=Tk.4000

Since first payment is Tk. 50,000, the person has purchased Tk. (50,000-4,000)-Tk.46,000
towards his house with his first payment. Tk. 46,000 is applied to the reduction of his debt and is
called the reduction of his principal. Thus, in the next month he owes only Tk (4,00,000-46,000)
=Tk. 3,54,000. Interest is then charged for the loan on this slightly smaller amount.

4
Compound Interest

If the interest on a particular principal sum is added to it after each prefixed period, the whole
amount earns interest for the next period, then the interest calculated in this manner is called
compound interest. The period after which interest becomes due is called interest period or
(conversion period). The interest due period may be yearly, half yearly, quarterly etc. Let an
initial amount of money P be invested at an interest rate of r percent per year for the period of n
years. The amount of interest at the end of the first year would become p x r. therefore, the total
amount at the end of the first year is given by

A₁ = P + P × r = P(1+r)

Similarly, the total amount at the end of the second year is given by A₂ = A₁ + A₁r = A₁ (1 + r) =
P (1 + r) (1 + r) = P(1+r) ².

The amount A acquired on a principal P after n payment periods at r% interest is

A₁ = P(1+r)"

In the compound interest formula, the rate of interest, r is given by

r=interest rate per year/ Number of compounding periods per year of money at the end of n
years.

If the normal rate I is quoted together with the frequency of conversion period, t per year or at

intervals of 1/t years, then the interest rate per period r is determined as:

5
r=i/t=Interest rate per year/Number of compounding periods per year

Thus, the compound interest formula for the amount A, accrued on a principal P at annual

interest rate I compounded t times year is:

An =P(1+ it )^ n ……………(ii)

The equation (ii) indicates that the value of the investment at the end of a period is the value at
the beginning of the period times the factor 1+(i/t)

The table 1 shows the growth pattern of an initial investment P at different periods:

Table-1: growth pattern of Money

Period Value at the Beginning Value at the end

1 P P

2 P(1+i/t) P(1+i/t)

3 P(1+i/t)2 P(1+i/t)2

4 P(1+i/t) (n-1) P(1+i/t)3

6
Table-2 shows the compound value of investment of Tk. I for different values of r and n

Table-2: Compound Value of Tk.1

Period 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

1 1.010 1.020 1 030 1.040 1.050 1.060 1.070 1.080 1.090 1.100

2 1.020 1.040 1.061 1.082 1.102 1.124 1.145 1.166 1.188 1.210

3 1.030 1.061 1.093 1.125 1.158 1.191 1.225 1.260 1.295 1.331

4 1.041 1.082 1.126 1.170 1.216 1.262 1.311 1.360 1.412 1.464

5 1.051 1.104 1.159 1.217 1.276 1.338 1.403 1.469 1.539 1.611

6 1.062 1.126 1.194 1.265 1.340 1.419 1.501 1.587 1.677 1.772

7 1.072 1.149 1.230 1.316 1.407 1.504 1.606 1.714 1.828 1.949

8 1.083 1.172 1.267 1.369 1.477 1.594 1.718 1.851 1.993 2.144

9 1.094 1.195 1.305 1.423 1.551 1.689 1.838 1.199 2.172 2.358

10 1.105 1.219 1.344 1.480 1.629 1.791 1.967 2.159 2.367 2.594

11 1.116 1.243 1.384 1.539 1.710 1.898 2.105 2.232 2.580 2.853

12 1.127 1.268 1.426 1.601 1.796 2.102 2.252 2.518 2.813 3.138

13 1.138 1.294 1.469 1.665 1.886 2.133 2.410 2.720 3.066 3.452

7
Special Cases: A = P * (1 + r/2)2n

if interest is compounded half yearly.

(ii) A = P * (1 + r/4)4n if interest is compounded quarterly.

In general, if the interest be compounded with a frequency t per year or at intervals of 1/t years,
then A = P * (1 + r/t)tn

Illustration-03: Find the number of years in which a sum of Tk. 1234 amounts to Tk. 5678 at 5%
per annum compound interest payable quarterly.

Solution: Given. P = 1234, A_{n} = 5678, t = 4 r/t = (5/4)%=0.0125, n = ?

Now applying the formula. A_{n} = P * (1 + r/t) ^ (tn), we get

5678 = 1234 * [1 + 0.0125] ^ (4n) or. (1.0125) ^ (4n) = 5678/1234

Taking logarithm on both sides, we have 4n * log (1.0125) = log 5678 - log 1234

or, 4n * 0.0086 = 3.7542 - 3.0913 = 0.6629 or, 4n = 77.08, or n = 30.69 years.

8
Illustration-03: If Tk. 500 were invested for 8 years at an interest rate of 6% compounded
quarterly. then what will be the compounded interest?

Solution: Given P = 500 n = 8, t = 4, r/t=(6/4)% = 0.015, A_{n}= ?

Now applying the formula,

A= P * (1 + r/t) ^ (nt), we get,

A= 500 * (1 + 0.015) ^ 32 = 500 * (1.015) ^ 32.

Taking logarithm on both sides, we have

log A_{n} = log 500+ 32log1.015=2.6990+32x0.0065 = 2.907

Then

A= anti log(2.907)=807,24

Hence, compound interest-A{n}-p=807.24-500 = Tk.307.24

Nominal and Effective Rate of Interest

The compound interest charged is based on annual rate of interest and the frequency of
compounding when interest is compound more than once a period, the annual rate is called the
nominal rate.

For example, suppose Tk. 1000 is invested for 5 years at 8% interest compounded annually.
Then the compounded amount and compound interest are

A=1000(1+0.08)5 = 1000(1.46933) = Tk. 1469.33

I = 1469.33-1000=Tk. 469.33

9
Continuous Compounding

For a fixed principal, time period and annual rate of interest, if the compound interest increase
continuously with the increase in the frequency of compounding, then such growth in investment
is called continuous compounding.

The compound amount or future value of an original principal p using continuous compounding
is A=Pein

ANNUITY

Many transactions in everyday life involve making a series of equal payments over a period of
time, such as mortgage, rent, etc. In general, a sequence of fixed annual payments (or receipts)
made at uniform (or equal) time intervals is called an annuity. The time between payments is
called the period, and the time from the beginning of the first period to the end of the last period
is called the term of the annuity. Annuity may be classified into two categories:

Annuity Certain: In case the first and last dates of an annuity are fixed, the annuity is called an
annuity certain, for example, installment payments. That is, payment period is fixed for a certain
number of years. Annuity certain may be further divided into two categories:

(a) Annuity due: The annuity in which the payment is made at the beginning of each period, i.e.;
all payments are to be made at the beginning of successive intervals, for example, rent or leases,
is called an annuity due.

(b) Annuity ordinary (or immediate): The annuity in which the payment is made at the end of
each period, i.e. all the payments are to be made at the end of successive interval, for example,
mortgages or loans, is called simple (or immediate) annuity.

Contingent Annuity: In case the term of payment depends on some uncertain event, the annuity
is called contingent annuity, for example insurance premium which is terminated with the death
of the insured person.

10
Deferred annuity: If the payments are deferred (or delayed) for a certain number of years, then
it is called deferred annuity. When it is deferred for n years, it is said to commence after n years,
and the first installment is made at the end of (n+1) years.

Remarks: 1. If we consider an ordinary annuity, the accumulated amount, denoted by

Sw=1+(1+i)+(1+i)2 +...+(1+i)n-1

(1+𝑖)−1
= [Sum of finite G.P.; with a=1,r=(1+i)]
𝑖

2. If instead of Tk. 1, we use payment of Tk. P at each payment period for an annuity at i percent
interest per payment period, the accumulated amount or sum of annuity after n payment periods
is:

A=Tk.PSn,i

DERIVATION OF DIFFERENT TYPES OF ANNUITIES

a. PRESENT VALUE OF AN ANNUITY

The present value of an annuity is the current value of the total amount of annuity at the end of
the given period. In other words, present value of a given sum if money due at the end of a
certain period of time is the sum of principal amount plus interest accumulated at the given rate
for the same period.

1. Present Value of Immediate Annuity (or Ordinary Annuity):-

Let a denote the annual payment of an ordinary annuity, n is the number of years and i percent is
the interest on one taka per year and P be the present value of the annuity. In the case of
immediate annuity, payments are made periodically at the end of specified period. Since the first
𝑎
installment is paid at the end of first year, its present value is 1+𝑖

11
 𝑎
the present value of second installment is (1+𝑖)2 and so on. If the present value of last installment
𝑎
is (1+𝑖)𝑛 then we have,

𝑎 𝑎 𝑎 𝑎
P= (1+𝑖)+(1+𝑖)2 + (1+𝑖)3 +………. +(1+𝑖)𝑛

1 1 1 1
=a [(1+𝑖)+(1+𝑖)2 + (1+𝑖)3 +………. +(1+𝑖)𝑛]

1
1 1−(1+𝑖)𝑛 1 1
=a.1+𝑖[ 1 ] ( here 1st term = 1+𝑖, common ratio= 1+𝑖 < 1)
1−
1+𝑖

1−𝑟 𝑛
For G.P series 𝑆𝑛 =𝑎. ; r< 1, where a is the 1st term and r is the common ratio
1−𝑟

1 1−𝑖 1
= 𝑎. 1−𝑟 . 1+𝑖−1[1 − (1+𝑖)𝑛 ]

𝑎 1
So, P or PV = 𝑖 [1 − (1+𝑖)𝑛]

For convenience, values of an,r for various values of n and r are given in table

Period 1% 2% 3% 4% 5% 6% 8% 10% 12%

1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9259 0.9091 0.8929

2 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.7833 1.7355 1.6906

3 2.9410 2.8839 2.8286 2.7751 2.7233 2.6730 2.5771 2.4869 2.4018

4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3121 3.1699 3.0374

12
 5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 3.9927 3.7908 3.6048

6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.6229 4.3553 4.1114

7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.2064 4.8684 4.5638

8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.7466 5.3349 4.9676

9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.2469 5.7590 5.3283

10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 6.7101 6.1446 5.6502

11 10.3676 9.7869 9.2526 8.7605 8.3064 7.8869 7.1390 6.4951 5.9377

12 11.2551 10.5753 9.9540 9.3851 8.8633 8.3838 7.5361 6.8137 6.1944

13 12.1337 11.3484 10.6350 9.9857 9.3936 8.8527 7.9038 7.1034 6.4236

14 13.0037 12.1063 11.2961 10.5631 9.8986 9.2950 8.2442 7.3667 6.6282

15 13.8651 12.8493 11.9380 11.1184 10.3797 9.7123 8.5595 7.6061 6.8109

13
2.Present Value of Annuity Due:

Since the first installment is paid at the beginning of the first period (year), its present value will
be the same as a where a is the annual payment of annuity due. The second installment is paid at
𝑎
the beginning of the second year, hence its present value is given as and so on , the last
1+𝑖

installment is paid in the beginning of n th year period, hence its present value is given as

(1+i) n-1

Thus, if P denotes the present value of annuity due then

𝑎 𝑎 𝑎
𝑝=𝑎+ + +⋯+
1 + 𝑖 (1 + 𝑖) 2 (1 + 𝑖)𝑛−1

1 1 1
= 𝑎 [1 + + 2
+⋯+ ]
(1 + 𝑖) (1 + 𝑖) (1 + 𝑖)𝑛−1
𝑛
1
{1 − [ ] }
(1 + 𝑖)
=𝑎
1
1−
(1 + 𝑖)

1
{1 − }
(1 + 𝑖)𝑛
=𝑎
(1 + 𝑖 − 1)
(1 + 𝑖)

1
1−
(1 + 𝑖)𝑛
= 𝑎(1 + 𝑖) [ ]
𝑖

𝑎 1
PV= (𝑎 + 𝑖 ) [1 − (1+𝑖)𝑛]

14
b. FUTURE VALUE OF AN ANNUITY

The future value of an annuity is the sum of all payments made and interest earned on them at
the end of the term of annuities.

3. Future Value or Amount of Immediate Annuity (or Ordinary Annuity):

Let a be the ordinary and i percent be the rate of interest per period. In ordinary annuity, the first
installment is paid after the end of first period. Therefore, it earns interest for (n-1) periods,
second installment earns interest for (n-2) periods and so on. The last installment earns for (n-n)
period, i.e. earns no interest. The amount of first annuity for (n-1) period at i percent rate per
period = 𝑎(1 + 𝑖) 𝑛−1second annuity = 𝑎(1 + 𝑖) 𝑛−2 third annuity = 𝑎(1 + 𝑖) 𝑛−3and so on. Thus,
the total annuity A for n period at i per cent rate of interest is:

A = (1 + 𝑖) 𝑛−1 + 𝑎(1 + 𝑖) 𝑛−2 + ⋯ + 𝑎(1 + 𝑖) + 𝑎

= 𝑎[1 + (1 + 𝑖) + ⋯ + (1 + 𝑖)𝑛−2 + (1 + 𝑖) 𝑛−1 ]

(1+𝑖) 𝑛 −1
=𝑎 (1+𝑖)−1

𝑎
A or FV = 𝑖 [(1 + 𝑖)𝑛 − 1]

4. Future Value or amount of Annuity Due:

As defined earlier, annuity due an annuity in which the payments are made at the beginning of
each period. The first installment will earn interest for a period at the rate of i percent per period.

15
Similarly, second installment will earn interest for (n-1) periods, and so on, the last installment
will earn interest for one period.

Hence the amount of annuity due

A=𝑎(1 + 𝑖)𝑛 + 𝑎(1 + 𝑖)𝑛−1 + 𝑎(1 + 𝑖)𝑛−2 + ⋯ + 𝑎(1 + 𝑖)1

=𝑎(1 + 𝑖)[1 + (1 + 𝑖) + (1 + 𝑖)2 + ⋯ + (1 + 𝑖)𝑛−1 ]

(1+𝑖)𝑛 −1
=(1 + 𝑖)𝑎 [ ]
1+𝑖−1

(1+𝑖)𝑛 −1
=(1 + 𝑖)𝑎 [ ]
𝑖

𝑎
A=(𝑎 + 𝑖 )[(1 + 𝑖)𝑛 − 1]

5. Perpetual Annuity:

Perpetual annuity is an annuity whose payment continues forever. As such the amount of
perpetuity is undefined as the amount increases without any limit as time passes on. We know
that the present value P of immediate annuity is given by

𝑎 1
P= 𝑖 [1 − (1+𝑖)𝑛 ]

1
Now as per the definition of perpetual annuity as n→→∞, we know that →0 since
(1+𝑖)𝑛

1 𝑎
1 + i > 1 , Hence, 𝑝 = 𝑖 [1 − 0] or PV= 𝑖

16
6. Deferred Annuity:

Amount of deferred annuity for n periods, differed m periods, is the value of the annuity at the
end of its term and is given as

𝑎 (1+𝑖)𝑛 −1
A= 𝑖 [ ]
(1+𝑖)𝑚

The present value of deferred annuity of n periods, deferred m periods, at the rate of i per year is
given as

𝑎 (1+𝑖)𝑛 −1
P= 𝑖 [(1+𝑖)𝑚+𝑛 ]

The derivation of the above formulae is considered as an exercise for the students.

Note: In all the above formulae the period is of one year. Now if the payment is made more than
𝑖
once in a year then i is replaced by 𝑘 and n is replaced by i where k is the number of payments in

a year.

17
 Business Problems

Illustration-04: The life of a machine is estimated 15 years. The original cost of the machine
is Tk. 12,000 and the depreciation on the reducing installment system being charged at
10% per annum. Find out the scrap value of the machine after the end of its life.

Solution;

𝑟 10 1
Given, P=12,000, i= = = , n=15, An=?
100 100 10

Using formula An = 𝑃(1 − 𝑖)𝑛 we get

9 15
or, An = 12000 (10)

or, log A= log 12,000+15 [ log 9-log10]

or, log A= 4.0792-0.6870

or, log A= 3.3922

Then, A=antilog (3.3922) =2467

Hence, the scrap value of the machine is TK. =2470

18
Illustration-05: A owes B TK. 1600 but it is due for payment till the end of 3 years from this
date. How much A should pay B if he willing to accept now in order to clear off the debt:
(a)taking money to be worth 5% per annum simple interest (b)taking to be worth 5% per
annum compound interest, payable yearly?

Solution: F=1600, n=3, i=5%

Requirement, P=?

a) For simple interest,

𝐹 1600 1600
P = 1+𝑛𝑖 =1+3×0.05= 1.15 = 𝑇𝐾. 1391.30 [Ans]

(b) For compound interest,

𝐹
P=(1+𝑖)𝑛 Let x=(1.05)3

Or, log x=3log1.05

1600
= (1+0.05)3

or, log x=3×0.0212

1600
=1.1577 or, log x=0.0636

=TK.1382 [Ans] or, x=anti log 0.0636

∴ 𝑥 = 1.1577

19
Illustration-06: A machine in a factory is valued at TK.49074 and it is decided to reduce the
estimated value at the end of each year by 15 percent of the value at the beginning of the
year. When will the value be (a)TK.20000, (b)1/𝟏𝟎𝒕𝒉 of the original value?

Solution:(a) Given A=20000, P=49074, d=15%=0.15

Requirement: n=?

∴A=P(1 − 𝑑)𝑛

Or,2000=49074(1 − 0.15)𝑛

20000
Or,49074 = (0.85)𝑛

Or,0.4075=(0.85)𝑛

Or, log0.4075=log(0.85)𝑛

𝑙𝑜𝑔0.4075
Or, n= 𝑙𝑜𝑔0.85

1.6101
Or, n=1.9294 [Using ʻ𝑙𝑜𝑔ʼ tables]

−1+.6101
Or, n=−1+.9294

−0.3899
Or, n=−0.0706

∴ 𝑛 = 5.52 𝑦𝑒𝑎𝑟𝑠[Ans]

49074
(b)Given, A= =4907.4 p=49074, d=15%=0.15
10

Require

n=?

∴ 𝐴 = 𝑃(1 − 𝑑)𝑛

Or,4907.4=49074(1 − .1501𝑛
20
 4907.4
Or, =(0.85)𝑛
49074

Log0.10=log(0.85)𝑛

Log0.10=nlog0.85

𝑙𝑜𝑔0.10
N =𝑙𝑜𝑔0.85

1.0000
N =1.9294

−1+.0000
Or , n=−1=.9294

∴ 𝑛 = 14.16 𝑦𝑒𝑎𝑟𝑠 [Ans]

Illustration-07: A machine depreciates at the rate of 10% of its value at the beginning of a
year. The machine was purchased for tk. 5810 and scrap value realized when sold was
TK.2250. find the number of years that the machine was used.

Solution: Given A=2250, P=5810, d=10%=0.10

Requirement: n=?

∴ 𝐴 = 𝑃(1 − 𝑑)𝑛

Or,2250=5810(1 − 0.10)𝑛

2250
Or,5810=(0.90)𝑛

Or, log0.3873=log(0.90)𝑛

Or, log0.3873=nlog0.90

𝑙𝑜𝑔0.3873
Or, n= 𝑙𝑜𝑔0.90

−1+.5880
Or, n=−1+.9542

21
n=8.9946

or, n=9years [Ans]

Illustration-08: A man borrows Tk.20000 at 4% C.I. and agrees to pay both the principal
and the interest in 10 equal installments at the end of each year. find the amount of each
installment.

Solution: Given P=20000, n=10, i=4%=0.04 let, x=(1.040−10

Requirement: A=? or, logx= -10log1.04

1−(1+𝐼)−𝑛
We have, P=A[ ] or, logx= -10×0.0170
𝑖

1−(1+0.04)−10
Or,20000=A[ ] or, logx= -0.1700
0.04

1−0.6761
=A[ ] or, x=antilog 1.8300
0.04

20000×0.04
A= ∴ x=0.6761
0.3239

=Tk.2470

[Ans.]

22
Illustration-09: A man borrows tk 1500 promising to repay the sum borrowed and the
proper interest by 10 equal yearly installments, the first two falling due in 1 years’ time.
Reckoning C.I. at 5% p.a. Find the value of the annual installment [Given (𝟏. 𝟎𝟓)𝟏𝟎 =1.629

Solution: Given P=1500, n=10, i=5%=0.05,(1.05)10 =1.629

Requirement: Annual installment (A)=?

1−(1+𝑖)−𝑛
∴P=A[ ] let x=(1.05)−10
𝑖

1−(1+0.05)−10
Or,1500=A[ ] or, log x=-10log1.05
0.05

1−0.6138
Or,1500=A[ ] or, log x=-0.212
0.05

Or,1500=a[7.724] or, logx=1.788

1500
Or, A=7.724 or, x= antilog1.788

=Tk.194.20 or, x=0.6138

[Ans.]

23
Conclusion:

Simple Interest: When interest is calculated only on the original principal, then it is called
simple interest (S.I.).

Compound Interest: When interest is calculated on both principal and successive interests then
it is called compound interest (C.I.).

Nominal Interest: The annual compound interest rate is called nominal rate of interest.

Effective Interest: When interest is compounded more than once in a year, then the actual
percentage of interest rate per year is called effective rate of interest.

Annuity: A sequence of equal payments made at equal time intervals is called an annuity.

Annuity Certain: An annuity payable for a fixed number of years is called annuity certain

Annuity Due: An annuity, which all payments are made at the beginning of each period, is
called annuity due. Examples: saving schemes, life insurance payments, etc.

Immediate Annuity: An annuity, in which all payments are made at the end of each period, is
called immediate annuity or ordinary annuity. Example: car loan, repayment of housing loan etc.

Annuity Contingent: In case the term of payment depends on some uncertain event, the annuity
is called annuity contingent.

24
Deferred Annuity: If the payments are deferred or delayed for a certain number of years, then it
is called deferred annuity. For example: pension plan etc. Many financial Organizations give
loan amount immediately and regular installments may start after specific time period.

Perpetual Annuity: An annuity whose payments continue forever is called perpetual annuity or
perpetuity. In this case, PV= a/i ; where a= payment of each installment, i=rate of interest.

Present value of an annuity: The present value of an annuity is the sum of present values of all
payments of annuity at the beginning of the annuity.

Future value of an annuity: The future value of an annuity is the sum of all payments made and
interest earned on them at the end of the term of annuities.

Sinking Fund: A type of savings fund, in which deposits are made regularly, with compound
interest earned, to be used later for a specific purpose, such as purchasing equipment or
buildings, is called sinking fund.

Amortization: A loan with fixed rate of interest is said to be amortized if both principal and
interest are paid by a sequence of equal payments with equal time periods. Purchasing a car by
making a series of periodic payments is an example of a loan that is amortized.

25