MC Math 08 (Mathematics of Investment)

MODULE 3
Chapter 3. Simple Annuities

I. Overview

This chapter focuses on simple annuities wherein annuity is a reasonable

alternative to some other investments as a source of income since it provides
guaranteed income to an individual. Annuities also occur in a variety of different settings.
For example, someone who is saving for someone who is saving for retirement by
investing a constant amount of money at the end of every month in an account that pays
a fixed interest rate is creating an ordinary annuity. Someone who wins the lottery and
who has selected the annuity payout option is paid a constant amount of money
immediately and every year thereafter for a fixed number of years—annuity due.

II. Desired Learning Outcomes

At the end of the chapter, the students are expected to:

1. find the future and present value of ordinary annuity;

2. solve the periodic payments of ordinary annuity;
3. find the future and present value of annuity due;
4. solve the periodic payments of annuity due; and
5. calculate the future value, present value and periodic payments of deferred
annuity.

Simple Annuities

An annuity is a sequence of equal payments made at equal intervals of time. The

interval between consecutive payments is called the payment interval. The interval may be
monthly, quarterly, semi-annually and annually. The term of an annuity is the time from the
beginning of the first payment interval through the day of the last payment.

Types of Annuities

1. Annuity Certain is an annuity whose term is fixed, when the term starts and ends on
definite dates. Thus, monthly payments in home appliances form an annuity certain
because the payments start on a specified date and continue regularly until the last
payment is made.

2. Contingent annuity is an annuity whose term depends upon some uncertain events.
Thus, life insurance premiums and pensions are examples of contingent annuity.

Simple annuities can be classified as:

1. Ordinary Annuity is an annuity whose payments are made at the end of each
payment interval.

2. Annuity Due is an annuity whose payments are made at the beginning of each
payment interval.
3. Deferred Annuity is an annuity whose first payment is to start at some future date.

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MC Math 08 (Mathematics of Investment)

The length of time from the present to the beginning of the fist payment interval is called
the period of deferment. Thus, an annuity consisting of annual payments, the first one to be
made at the end of 5 years, would be described as a deferred annuity, the period of
deferment being 4 years.

FUTURE VALUE AND PRESENT VALUE OF AN ORDINARY ANNUITY

The Future value of an ordinary annuity is the total if all periodic payments due at the
end of the term. The present value of an ordinary annuity is the total of the present value of
all the periodic payments.

Formulas:

a. Future Value
(1+�)� −1
FVA = Pmt [ ]
�
b. Present Value
1−(1+�)−�
PVA = Pmt [
�
Where:

FVA = Future value of an ordinary annuity

PVA = Present value of an ordinary annuity
Pmt = Regular or periodic payment
n = Number of conversion Periods, n = m x t
�
i = Interest rate per conversion period, i =
�
m = Conversion period
t = time in expressed in years

Illustration:

What is the future value and present value of an annuity of ₱400 payable every
end of the month for 7 years if money is worth 9% compounded monthly?

a. Given:
9
Pmt = ₱400 n = 12 x 7 = 84 i=
12
% or 0.0075

Solution:
(1+�)� −1
FVA = Pmt [ ]
�
(1+ 0.0075)84 −1
= 400 [ ]
0.0075
= 400 [ 116.426928446163 ]
= 46, 570.77

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MC Math 08 (Mathematics of Investment)

b. Given:
9
Pmt = ₱400 n = 12 x 7 = 84 i=
12
% or 0.0075

Solution:

1−(1+�)−�
PVA = Pmt [
�
1−(1+0.0075)−84
= 400 [
0.0075
= 400 [ 62.1539645613983)
= 24, 861.59

PERIODIC PAYMENTS OF ORDINARY ANNUITY

Formulas:
a. Periodic Payment of FV (Future Value)
FVA (�)
Pmt=
(1+�)� −1
b. Periodic Payment of PV (Present Value)
PVA (�)
Pmt= 1
1−(1+�)�

Illustration:

1. If money is worth 9% compounded quarterly, how much must a man save

every 3 months to accumulate ₱10,000 in 4 years.
9
Given: FVA = ₱10,000 n = 4 x 4 = 16 i = 4% or 0.0225

Solution:
FVA (�)
Pmt =
(1+�)� −1
10,000 (0.0225)
=
(1+0.0225)16 −1
225
=
0.42762145745072
225
=
0.42762145745072
= 526.17

2. Find the monthly Payment of an ordinary annuity if the present value is

₱12,000 with interest rate of 9%, m = 12 and a term of 8 years.

9
Given: PVA = ₱12,000 n = 8 x 12 = 96 i = 12% or 0.0075

Solution:

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MC Math 08 (Mathematics of Investment)

PVA (�)
Pmt= 1
1−(1+�)�

12,000 (0.0075)
= 1
1−
(1+0.0075)96
90
=
0.51193828917498

= 175.80

ANNUITY DUE

An annuity due is an annuity whose payments are made at the beginning of each
payment interval, rather than at the end. The present value of an annuity due is the sum of all
present values of the payments at the time of the first payment. The amount of an annuity due
is the sum of all the accumulated amounts of the payments at the end of the term.

Formulas:

a. Future Value of the annuity due

(1+�)� −1
FVAD = Pmt [(1 + i)�−1� FVAD = Pmt [ ] (1 +
�
i)

b. Present value of the annuity due

[ ]
1−
(1+�)�−1
PVAD = Pmt + Pmt
�

c. Periodic payment of Future Value of annuity due

퐹 퐴
PmtAD = 1+� � −1
�
(1+�)

d. Periodic Payment of Present value of annuity due

푃 퐴
PmtAD = 1
1−
(1+�)�−1
�
+1

Illustration:

1. An investment of ₱280 is made at the beginning of each month for 5 years. If

interest is 9% compounded monthly how much will the investment be at the
end of 5 years.

Given:
9
Pmt = ₱280 ; n = 5 x 12 = 60 ; i= % = 0.0075
12

Solution:

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MC Math 08 (Mathematics of Investment)

(1+�)� −1
FVAD = Pmt [ ] (1 + i)
�
(1+0.0075)60 −1
FVAD = 280 [ ] (1 + 0.0075)
0.0075
FVAD = 280 (75.424136925542) (1 + 0.0075)
FVAD = 21,277.15

2. Find the present value of ₱300 paid at the beginning of every 3 months for 10
years at 8% compounded quarterly.

Given:
8
Pmt = ₱300 ; n = 10 x 4 = 40 ; i = % or 2% or 0.02
4
Solution:
1

[ ]
1−
(1+�)�−1
PVAD = Pmt + Pmt
�
1

[ ]
1−
(1+0.02)40−1
PVAD = 300 + 300
0.02
PVAD = 300 (26.9025888255529) + 300
PVAD = 8,370.78

3. Miss Capulong wants have ₱30,000 for a trip 3 years form now. How much
must she save the beginning of each month starting now, if she gets 6%
converted monthly on her savings?

Given:
6 1
FVAD = 30,000 ; n = 3 x 12 = 36 i = % or % or
12 2
0.005
Solution:
퐹 퐴
PmtAD = �
1+� −1
�
(1+�)
30,000
PmtAD =
1+0.005 36 −1
0.005
(1+0.005)
30,000
PmtAD =
1+0.005 36 −1
0.005
(1+0.005)
30,000
PmtAD =
39.5327854895073
PmtAD = 758.86

4. The annual premium on a car insurance policy is ₱1,650 payable in advance.

What would be the quarterly premium if the interest rate is based on 6%
compounded quarterly?

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MC Math 08 (Mathematics of Investment)

Given:
6
PVAD = ₱1,650 ; n=4x1=4; i = % or 0.015
4
Solution:
푃 퐴
PmtAD = 1
1−
(1+�)�−1
�
+1
1,650
PmtAD = 1
1−
(1+0.015)4−1
0.015
+1

PmtAD = 421.76

DEFFERED ANNUITY

Deferred Annuity is annuity in which the first payment is not made at the beginning nor at
the end of the first payment interval but at a later date, that is, the term begins at a future time.
Thus, an annuity of quarterly payments which has been deferred 2 years will have the first
1
payment at the end of 2 4 years. Likewise, an annuity whose first payment is made at the end
3
of 2 years is deferred 1 years. The length if time from the present to the beginning of the
4
first payment interval is called the deferment period.

Formulas:

a. Present Value
(1+�)−� − (1+�)−(�+�)
PVA = Pmt [ ]
�

b. Periodic Payment of Present Value

푃 퐴 (�)
Pmt = 1 1
� −
(1+�) �+�
(1+�)

c. Future Value

(1+�)� −1
FVA = Pmt [ ]
�

Where:

FVA = Future value of an ordinary annuity

PVA = Present value of an ordinary annuity
Pmt = Regular or periodic payment
n = Number of conversion Periods, n = m x t
�
i = Interest rate per conversion period, i =
�
k = No. of deferred periods
m = Conversion period
t = time in expressed in years

Finding the number of deferred periods

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MC Math 08 (Mathematics of Investment)

One way to find the period of deferral is to count the number of artificial payments

Example 1:
Find the present value of a deferred annuity of ₱250 every 6 months for 7 years if
the first payment is made in 3 years, and the money is worth 8% converted semi-
annually.

Solution:
Since m = 2, therefore it must be divided into 2 periods per year.

5 periods First payment made

1 2 3 4 5 6

Counting from 1st period to the last period before the first payment is equals to 5,
it means k = 5

Or, k= 3 x 2 – 1 = 5, since payment is made in 3 years

Example 2:
Find the present value of a deferred annuity of ₱100 every three months for 8
years that is deferred 2 years if money is worth 10% compounded quarterly

Solution:
Since m = 4, therefore it must be divided into 4 periods per year.

8 periods First payment made

1 2 3

Counting from 1st period to the last period before the first payment is equals to 8,
it means k = 8

Or, k= 2 x 4 = 8, since payment is made after 2 years

Deferred Annuity problems with solutions

Illustrations:

1. Find the present value of a deferred annuity of ₱250 every 6 months for 7 years if
the first payment is made in 3 years, and the money is worth 8% converted semi-
annually.

Given:
8
Pmt = ₱250 ; n = 7 x 2 = 14 ; i = % = 4% or 0.04 ; k = 3 x 2 -1 = 5
2

Solution:
(1+�)−� − (1+�)−(�+�)
PVA = Pmt [ ]
�
(1+0.04)−5 − (1+0.04)−(5+14)
PVA = 250 [ ]
0.04

PVA = 250 (8.68211706775019)

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MC Math 08 (Mathematics of Investment)

PVA = 2,170.52

2. Find the present value of a deferred annuity of ₱100 every three months for 8
years that is deferred 2 years if money is worth 10% compounded quarterly?

Given:
10
Pmt = ₱100 ; n = 8 x 4 = 32 ; i = % = or 0.025 ; k=2x4=8
4

Solution:
(1+�)−� − (1+�)−(�+�)
PVA = Pmt [ ]
�
(1+0.025)−8 − (1+0.025)−(8+32)
PVA = 100 [ ]
0.025
PVA = 100 (17.9326378846115)
PVA = 1,793.26

3. If money is worth 9% compounded monthly, what equal monthly payments at the

end of each month for 4 years will pay off a debt of ₱18,000, the first payment is
due in 1 year and 4 months.

Given:
9 1
PVA = ₱18,000 ; n = 4 x 12 = 48 ; i = % = or 0.0075 ; k = 1 x 12 -1 = 15
12 3
Solution:
푃 퐴 (�)
Pmt = 1 1
� −
(1+�) �+�
(1+�)
18,000 (0.0075)
Pmt = 1 1
15 −
(1+0.0075) (1+0.0075)15+48
135
Pmt =
0.26943068583323
Pmt = 501.06

III. Self-check
Direction: Solve each of following problems. Write your answer in a separate paper

A. Ordinary Annuity

1. What is the Present value of 20 payments of ₱2,800 at the end of each 6 months
with interest at 9% compounded semi-annually?
2. What equal payments at the end of each month for 15 years would purchase a
house and lot worth ₱250,000 cash if the interest rate is 18%, m = 12?
3. Find the Future value of deposit s of ₱2,500 at the end of each 6 months for 10 years
if a fund which offers 14% interest compounded semi-annually.
4. A commercial bank pays interest at 13%, m = 2 on all time deposits. What sequence
of equal deposits at the end of each six months. For 5 years would accumulate to
₱120,000?

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MC Math 08 (Mathematics of Investment)

5. To provide for his daughter’s college education, a man deposits ₱2,000 at the end of
each 3 months for 6 years. If the money draws 9% interest converted quarterly, how
much does the fund contain after 6 years?
6. What Periodic payment is needed to be paid every 6 months for 6 years to discharge
a loan of ₱10,500 at 9% converted semi-annually?

B. Annuity Due
7. For each of the following annuity dues, Find the future and present value.

Payment made Term Rate of interest

a. ₱600 semi-annually 5 years 16%, m = 2
b. ₱375 monthly 7 years 17%, m = 12
8. A component stereo set can be bought by payments of ₱1,400 at the beginning of
each month for 2 years. If interest is at 17% converted monthly, find the equivalent
cash value of the set.
9. What deposits should be made at the beginning each three months in a savings
bank that pays 8% compounded quarterly in order to have ₱18,000 at the end of 3
years.
10. A debt of ₱15,700 is due in 6 years. The debtor agrees to pay the obligation in 6
equal annual payments, the first of which is to be made immediately. What will be the
regular payment if the money is worth 17%?

C. Deferred Annuity

11. Find the present value of a deferred annuity of ₱350 every 3 months for 6 years that
is deferred 2 years and 9 months, if money is worth 8% compounded quarterly.
12. What is the present value of annuity in which Miss Benedicto agrees to pay a
financing Company a monthly installment of ₱280 for 5 years, the first payment to be
made a year after the date of purchase? Money is worth 16% compounded monthly.
13. In a series of quarterly payments of ₱750 each, the first payment is due at the end of
6 years and the last at the end of 15 years. Find the present value of the deferred
annuity if money us worth 16% m = 4.
14. Find the quarterly payment of 3 years to settle an obligation of ₱15,00. Money is
worth 18% converted quarterly and the first payment is due at the end of one year
and a half.
15. A couple borrows ₱150,000 and agrees to settle this by making equal payments
every month for 7 years. The first payment is due at the end of 1 year. Find the size
of the monthly payment if money is worth 17% compounded month

Chapter 4. Amortization and Sinking Fund

I. Overview

This chapter focuses on simple annuities wherein annuity is a reasonable

alternative to some other investments as a source of income since it provides
guaranteed income to an individual. Annuities also occur in a variety of different settings.
For example, someone who is saving for someone who is saving for retirement by
investing a constant amount of money at the end of every month in an account that pays
a fixed interest rate is creating an ordinary annuity. Someone who wins the lottery and
who has selected the annuity payout option is paid a constant amount of money
immediately and every year thereafter for a fixed number of years—annuity due.

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MC Math 08 (Mathematics of Investment)

II. Desired Learning Outcomes

At the end of the chapter, the students are expected to:

6. find the future and present value of ordinary annuity;

7. solve the periodic payments of ordinary annuity;
8. find the future and present value of annuity due;
9. solve the periodic payments of annuity due; and
10. calculate the future value, present value and periodic payments of deferred
annuity.

AMORTIZATION

Amortization commonly refers to the periodic payment of a debt as to principal and

interest by means of a sequence of equal periodic payments due at the end of equal intervals of
time. These equal payments form an annuity of the simple case whose present value is the
original principal of the obligation.

Steps in the Construction of an Amortization Schedule

1. Find the Pmt, the periodic payment by:

a. Ordinary annuity:
PVA (�)
Pmt= 1
1−(1+�)�

b. Annuity Due:
푃 퐴
PmtAD = 1
1−
(1+�)�−1
�
+1
c. Deferred Annuity:
푃 퐴 (�)
Pmt = 1 1
(1+�)� − �+�
(1+�)

2. Construct the Amortization Schedule

Amortization schedule is a table which shows how much is applied to reduce the
principal and how much is paid for interest to indicate the remaining liabilities on the
outstanding principal after each payment period.

Illustrative Problem:

A loan of ₱10,000 is to be charged by equal payments at the end of each year for
6 years. If the interest is based on 5% compounded annually, construct an
amortization schedule.

Solution:

1. Find the Pmt, the annual payment, by using the ordinary annuity formula for
Pmt:
5%
PVA = ₱10,000 ; n = 6 x 1 = 6 ; i = 1
or 5% or 0.05

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MC Math 08 (Mathematics of Investment)

PVA (�)
Pmt= 1
1−(1+�)�

10,000(0.05)
= 1
1−
(1+0.05)6
= ₱1,970.175

2. Construct the amortization schedule

Outstanding Interest at Principal

Payment Principal at 5% Due at Pmt, Yearly repaid at
Number the beginning the end of payment the end of
of the year the year, i the year
1 ₱10,000.000 ₱500.00 ₱1,970.175 ₱1,470.175
2 ₱8,529.825 ₱426.491 ₱1,970.175 ₱1,543.684
3 ₱6,986.141 ₱349.307 ₱1,970.175 ₱1,620.868
4 ₱5,365.273 ₱268.264 ₱1,970.175 ₱1,701.911
5 ₱3,663.362 ₱183.168 ₱1,970.175 ₱1,787.007
6 ₱1,876.355 ₱93.818 ₱1,970.175 ₱1,876.357
TOTALS ₱1,821.048 ₱11,821.050 ₱10,000.000

Where:

 The total number of Payment number depends on the value of n

 Outstanding principal starts from the present value and every year
it is subtracted by the principal repaid at the end of the year.
 Principal repaid at the end of the year can be computed if you
subtract the interest due at the end of the year from the yearly
payment.

Finding the outstanding Principal without using the Amortization Schedule.

The outstanding liability at any date is the present value of all unpaid periodic payments.
When table is extensive, the remaining liability at any date can be obtained by prospective
method.

Prospective method. This simple method is used when all payments are regular and equal.
Outstanding Principal = Present value of all unpaid periodic payments

1−(1+�)−(�−�)
P = Pmt
�

Where:
P = outstanding principal
Pmt = Periodic Payment
i = interest rate per conversion period
n = number of conversion periods or the number of payments, n = m x t
k = number of paid payments
n – k = Number of unpaid payments

Illustrative Problem

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MC Math 08 (Mathematics of Investment)

Lourdes borrows ₱10,000 from PBM Bank with interest at 16% m =4 to be repaid by
equal quarterly payments in one year. Find a) her remaining liability just after the second
payment b) the principal which will be paid on her third payment.

Given:
16%
PV = 10,000 ; n = 4 x 1 = 4 i = or 4% or 0.04
4
Solution:

a. 1st step Find the Value of Pmt

PVA (�)
Pmt= 1
1−(1+�)�

10,000 (0.04)
Pmt= 1
1−
(1+0.04)4
Pmt = ₱2,754.9005
2nd step, find the remaining liability just after second payment by:
1− 1+� −(�−�)
P = Pmt since it is after second payment it means 2
�
payments are already paid, thus, k = 2

1−(1+0.04)−(4−2)
P = 2,754.9005
0.04
P = ₱5,196.00

b. The third payment provides interest on the principal outstanding just after the second
payment.

Interest on ₱5,196.00 for 1 quarter at 4%

I= (5,196.00) (0.04) = ₱207.84

Principal repaid on third payment:

= ₱2,754.90 -- ₱207.84 = ₱2,547.06

SINKING FUND

This refers to savings fund created by investing equal periodic payments. It is designed
to insure the accumulation if a desired amount of money upon a specific date.

Sinking Formulas

a. Ordinary Annuity:
(1+�)� −1
FVA = Pmt [ ]
�
FVA (�)
Pmt=
(1+�)� −1
b. Annuity Due:
(1+�)� −1
FVAD = Pmt [ ] (1 + i)
�

퐹 퐴
PmtAD = �
1+� −1
�
(1+�)

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MC Math 08 (Mathematics of Investment)

Illustrative Problem:

In order to provide ₱10,000 for the repair and maintenance of his car, Euclid decides to
place equal deposits in a fund at the end of each months. If money is invested at 8%, m = 2

a. Find the periodic deposit;

b. Form a table showing the growth of the sinking fund in to ₱10,000 at the end of 2
years.

Solution:
8%
FVAD = ₱10,000 ; n = 2 x 2 = 4; i = = 4% or 0.04
2
a. Periodic Payment or Deposit
FVA (�)
Pmt=
(1+�)� −1
10,000(0.04)
Pmt=
(1+0.04)4 −1

Pmt= ₱2,354.90
b. Table showing Growth if Sinking Fund

Interest
In Fund at Amount in
Earned at Periodic
Payment the fund at the
4% on Fund Payment,
Interval Beginning of end of
at the end Pmt
Interval Interval
of Interval, i
1 ₱0.000 ₱0.000 ₱2,354.900 ₱2,354.900
2 ₱2,354.900 ₱94.196 ₱2,354.900 ₱4,803.996
3 ₱4,803.996 ₱192.160 ₱2,354.900 ₱7,351.056
4 ₱7,351.056 ₱294.042 ₱2,354.900 * ₱10,000.00
* Sometimes the final amount is less or greater by few centavos than the desired amount
due to rounding errors.

Where;

 The total number of Payment interval depends on the of n

 In fund at the beginning of interval start with ₱0 and the
succeeding year will have the amount in fund at the end of interval
 Amount in fund at the end of interval can be computed by adding
the fund at the beginning of the interval, interest earned and the
periodic payment.

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