CHAPTER 6: OTHER TYPES OF
ANNUITIES
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OVERVIEW
6.1 Deferred [Link]
6.2 [Link]
6.3 Constant-Growth [Link]
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6.1 DEFERRED ANNUITIES
• A deferred annuity is an annuity in which the first periodic payment is
made after an interval that is not equal to the payment period. This
interval is known as the deferral period. The deferral period is the time
interval from 'now' to the beginning of the annuity period.
• 2 types of deferred annuities:
• Ordinary Deferred Annuity: If the deferral period ends one payment interval
before the first periodic payment, then it is an ordinary deferred annuity.
• Deferred Annuity Due: If the deferral period ends at the beginning of the first
periodic payment, then it is a deferred annuity due
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6.1 DEFERRED ANNUITIES
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6.1 DEFERRED ANNUITIES
• A deferred annuity due can be modified to become an ordinary
deferred annuity by shortening the deferral period by one payment
period
• The payments made at the beginning of each payment period can be
accommodated by making them into payments made at the end of each
payment period
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EXAMPLE
Payments of $1000 are made at the beginning of each year for ten years
with the first payment being made three years from now.
a. Assuming the annuity is a deferred annuity due, identify the deferral
period and the annuity period.
b. Assuming the annuity is an ordinary deferred annuity, identify the
deferral period and the annuity period.
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EXAMPLE
a.
• Deferral period ends at the first periodic payment
• Payments start 3 years from now
• The deferral period is 3 years
• The annuity period is 10 years
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EXAMPLE
b.
• Deferral period ends one payment interval before the first periodic
payment
• Payments start 3years from now
• The deferral period is 2 years
• The annuity period is 10 years
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CALCULATING FV AND PV OF A DEFFERED ANNUITY
• The future value of a deferred annuity is the accumulated value of the
stream of payments at the end of the annuity period. This is the same
procedure as [Link] the future value of any annuity
• The present value of a deferred annuity is the discounted value of the
stream of payments at the beginning of the deferral period
Example: What amount should you invest now if you want to receive
payments of $1000 every year for ten years with the first payment to be
received three years from now? Assume that money earns 5%
compounded annually.
a. [Link] the annuity as an ordinary deferred annuity
b. [Link] the annuity as a deferred annuity due
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NOTE
• Whenever the periodic payment is specified to occur at the end of the
payment interval, we will treat the annuity as an ordinary deferred
annuity
• Whenever the periodic payment is specified to occur at the beginning
of the payment interval, we will treat the annuity as a deferred annuity
due
• However, any deferred annuity can be treated as either an ordinary
deferred annuity or a deferred annuity due.
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EXAMPLES
• Calculate the amount of money an investment banker would have to deposit in an
investment fund that will provide him with $1000 at the beginning of each month
for 11 years. He will receive his first payment two years from now and the interest
rate is 6% compounded semi-annually.
• The owner of a business borrowed $7500 to purchase a new machine for his
factory. The interest rate charged on the loan is 4% compounded semi-annually and
he is required to seIle the loan by making equal monthly payments at the end of
each month for 5 years, with the first payment to be made 1 year and 1 month
from now. Calculate the size of the monthly payments that are required to seIle
the loan.
• Third Eye Glassware CorporaMon invested its annual net profits of $500,000 in a
fixed deposit at 8% compounded quarterly. It wants to withdraw $90,000 at the
beginning of every year, with the first withdrawal to be made 3 years from now.
Calculate the Mme period of the annuity. Round your answer up to the next
payment period
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6.2 PERPETUITIES
• A perpetuity is an annuity in which the periodic payments begin on a
fixed date and [Link] indefinitely. Therefore, it is not possible to
calculate its future value
• However, there is a definite present value for a perpetuity.
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CALCULATING THE PV OF A PERPETUITIES
• The formula for the present value of an ordinary perpetuity:
1 − (1 + 𝑖)!"
𝑃𝑉 = 𝑃𝑀𝑇×
𝑖
• As the number of payments, n, in an annuity increases, the value of
(1+i)-n becomes smaller. Therefore, as n approaches infinity, as in the
case of a perpetuity, the value of (1+i)-n approaches 0
𝑃𝑀𝑇
𝑃𝑉#$%# =
𝑖
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PERPETUITY DUE
• Similar to annuities, perpetuities can be classified as:
• Ordinary perpetuity or perpetuity due
• Ordinary deferred perpetuity or deferred perpetuity due
• PV of a Perpetuity Due:
𝑃𝑀𝑇
𝑃𝑉#$%# &'$ = (1 + 𝑖)
𝑖
• A few examples of perpetuities include:
• Continuous interest payments from a lump sum of money invested at a fixed
interest rate
• A scholarship to students paid from an endowment fund on a perpetual basis
• A charity fund established to provide regular payments indefinitely to needy
children
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EXAMPLES
• A college wants to provide students with a perpetual scholarship of $10,000 at the
end of every 3 months. How large should its endowment fund be if the money is
growing at 8% compounded quarterly?
• A wealthy donor sponsors an endowment fund that provides a hospital with $5000
at the beginning of every month in perpetuity. What is the sponsorship amount if
the fund is growing at 8% compounded quarterly?
• A large telecommunicaMons company purchases a perpetual bond at $500,000 that
earns interest of 5.75% compounded monthly. Calculate the end-of-quarter
payments that will be received from the bond.
• Green Splash Publishers wants to invest a lump sum amount in a fund growing at
6% compounded monthly. It plans to withdraw $2000 at the beginning of every
month from the fund with the first withdrawal to be made two years from now.
How much should it invest in the fund?
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6.3 CONSTANT-GROWTH ANNUITIES
• A constant-growth annuity is an annuity where the periodic payment
amount (PMT) increases by a constant rate (g) over the preceding
payment amount.
• A few examples of constant-growth annuities include:
• Retirement annuity contracts
• Insurance policies
• Leases
• Installment purchases
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EXAMPLE
You plan to deposit regular payments at the end of every month for 3
years, [Link] with an [Link] investment of $100, and increasing the
amount by 2% every month
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CALCUATING FV AND PV OF AN ORDINARY CONSTANT- GROWTH ANNUITY
• Future Value of an Ordinary Constant-Growth Annuity:
(1 + 𝑖)! −(1 + 𝑔)!
𝐹𝑉 = 𝑃𝑀𝑇×
𝑖−𝑔
• Present Value of an Ordinary Constant-Growth Annuity:
1 − (1 + 𝑔)! ×(1 + 𝑖)"!
𝑃𝑉 = 𝑃𝑀𝑇×
𝑖−𝑔
• Sum of Constant-Growth Payments:
(1 + 𝑔)! −1
𝑆𝑢𝑚 = 𝑃𝑀𝑇×
𝑔
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EXAMPLES
• A business made end-ot-month investments in a high-growth fund star4ng at $500 and increased it
by 1.5% per month therea>er, for 15 years. The fund has an interest rate of 12% compounded
monthly.
a. What was the accumulated amount in the fund at the end of the period?
b. What was the total interest earned?
• Abel purchased a ten-year annuity that has an interest rate of 5% compounded semi-annually and
will provide him with payments at the end of every six months. The first payment received is $1000
and it increases by 2% therea>er, every six months.
a. How much did he pay for the annuity?
b. What was the total interest earned?
• Pejman made contribu4ons growing at 2.25% at the end of every 3 months to his account that was
earning 8% compounded quarterly. In 30 years, his savings had accumulated to $147,034.45.
a. What was the size of the first contribu4on?
b. What was the total interest earned?
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THANK YOU !
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