ANNUITY

CHARINA C.
FAMERO
 ANNUITY
An annuity is described as a stream of fixed cash flows, i.e.
payments or receipts, that occurs periodically, over time. For
example, payment of housing loan, life insurance premium, rent,
etc. There can be two types of annuities, i.e. ordinary annuity
and annuity due.
Most of the people use an annuity as a retirement tool
(pension) that guarantees steady income in the coming years. An
equal amount should be paid or received as an annuity and the
time lag between payments occurring consecutively should be
same.
 Definition of Ordinary Annuity

Ordinary Annuity is defined as a series of regular

payments or receipts; that occurs at regular intervals over a
specified number of periods. It is also known as annuity
regular or deferred annuity.
In general, ordinary annuity payment is made on a
monthly, quarterly, semi-annual or annual basis. The
present value of the ordinary annuity is computed as of one
period prior to the first cash flow, and the future value is
computed as of the last cash flow.
 Ordinary Annuity
Formula:
Present Value (PV) of ordinary annuity: P = PMT [(1 – (1 + r) n ) / r]
where, PMT = Period cash payment
P = The present value of the annuity stream to be paid in the future
PMT = The amount of each annuity payment
C
r = Interest rate

n = Total number of periods

Future Value (FV) of ordinary annuity: P = PMT [((1+r)n-1)/r]

P = The future value of the annuity stream to be paid in the future
PMT = The amount of each annuity payment
r = Interest rate
n = Total number of periods
Present Value of Ordinary Annuity

For example, ABC International has committed to a

legal settlement that requires it to pay 50,000 per year
at the end of each of the next ten years. What would it
cost ABC if it were to instead settle the claim
immediately with a single payment, assuming an
interest rate of 5%? The calculation is:

P = 50,000[(1-(1/(1+.05)10))/.05]
P = 386,087
 Future Value of Ordinary Annuity

For example, the treasurer of ABC International expects to

invest $100,000 of the firm's funds in a long-term investment
vehicle at the end of each year for the next five years. He
expects that the company will earn 7% interest that will
compound annually. The value that these payments should
have at the end of the five-year period is calculated as:

P = $100,000 [((1 + .07)5 - 1) / .07]

 
P = $575,074
 Future Value of Ordinary Annuity
 As another example, what if the interest on the investment
compounded monthly instead of annually, and the amount
invested were $8,000 at the end of month? The calculation is:
 
P = $8,000 [((1 + .005833)60 - 1) / .005833]
 
P = $572,737
 
The .005833 interest rate used in the last example is 1/12th of
the full 7% annual interest rate.
 Definition of Annuity Due
Annuity Due or immediate is nothing but the sequence of periodic cash
flows (payments or receipts) regularly occurring at the end of each period
overtime. The first cash flow of the annuity falls due at the present time. The
most common example of an annuity due is the rent, as the payment should
be made at the start of the new month.
As in the case of an ordinary annuity, the present and future values of the
annuity due are also calculated as first and last cash flows respectively.
Formula:
Present Value (PV) of Annuity Due: PMT + PMT × ((1 – (1 + r) ^ -(n-1) / r)
where, PMT = Period cash payment
r = Interest rate per period
n = Total number of periods
 BASIS FOR
ORDINARY ANNUITY ANNUITY DUE
COMPARISONS
Ordinary annuity is Annuity due is
one in which the described as the series
inflow or outflow of of cash flows
Meaning cash fall due for occurring at the
payment at the end of beginning of each
each period. period.

Belongs to the period Belongs to the period

Payment preceding its date following its date.

Payments Receipts
Appropriate for

Housing loan, Rental lease

payment of mortgage, payments, life
Example coupon bearing bonds, insurance premium,
etc. etc.
 CONCLUSION
Annuity aims at providing a constant stream of
income to the annuity holder for a long time. An
individual can make a choice between these two
annuities considering some factors, such as the
income that he wants during retirement and the
degree of risk he is able to take. Ordinary annuity
means an annuity which is related to the period
preceding its date, whereas annuity due is the annuity
related to the period following its date.