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Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
6.3 Annuities; Sinking Funds
Section 6.3 p17
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.3 p18
An annuity is a sequence of equal periodic deposits. The
periodic deposits can be annual, semiannual, quarterly,
monthly, or any other fixed length of time.
When the deposits are made at the same time the interest is
credited, the annuity is termed ordinary*.
The amount of an annuity is the sum of all deposits made
plus all interest accumulated.
*We shall concern ourselves only with ordinary annuities in this book.
6.3 Annuities; Sinking Funds
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.3 p19
Theorem
Amount of an Annuity
Suppose P is the deposit made at the end of each payment
period for an annuity paying an interest rate of i per
payment period.
The amount A of the annuity after n deposits is
(1)
6.3 Annuities; Sinking Funds
(1 ) 1
n
i
A P
i
| |
+
=
|
\ .
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.3 p20
A person with a debt may decide to accumulate sufficient
funds to pay off the debt by agreeing to set aside enough
money each month (or quarter, or year) so that when the
debt becomes payable, the money set aside each month plus
the interest earned will equal the debt.
The fund created by such a plan is called a sinking fund.
6.3 Annuities; Sinking Funds
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
6.4 Present Value of an Annuity;
Amortization
Section 6.4 p21
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p22
The present value of an annuity is the sum of the present
values of the withdrawals.
In other words, the present value of an annuity is the
amount of money needed now so that if it is invested at a
rate of i per payment period, n equal dollar amounts can be
withdrawn without any money left over.
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p23
Theorem
Present Value of an Annuity
Suppose an annuity earns interest at the rate of i per
payment period. If n withdrawals of $P are made at each
payment period, the amount V required is
(1)
Here V is called the present value of the annuity.
1 (1 )
n
i
V P
i
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+
=
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\ .
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p24
A loan with a fixed rate of interest is said to be amortized if
both principal and interest are paid by a sequence of equal
payments made over equal periods of time.
(The Latin word mort means death. Paying off a loan is
regarded as killing it.)
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p25
Theorem
Amortization
The payment P required to pay off a loan of V dollars
borrowed for n payment periods at a rate of interest i per
payment period is
(2)
1 (1 )
n
i
P V
i
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=
|
+
\ .
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p26
Definition
Face Amount (Face Value or Par Value)
The face amount or denomination of a bond (normally
$1000) is the amount paid to the bondholder at maturity.
It is also the amount usually paid by the bondholder when
the bond is originally issued.
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p27
Definition
Nominal Interest (Coupon Rate)
The nominal interest or coupon rate is the contractual interest
paid on the bond.
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p28
Nominal interest is normally quoted as an annual
percentage of the face amount.
Nominal interest payments are conventionally made
semiannually, so semiannual periods are used for
compound interest calculations.
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.4 p29
When the bond price is higher than the face amount, it is
trading at a premium;
when it is lower, it is trading at a discount.
For example, a bond with a face amount of $1000 and a
coupon rate of 8% may trade in the marketplace at a price of
$1100, which means the true yield is less than 8%.
To obtain the true interest rate of a bond, we view the bond
as a combination of an annuity of semiannual interest
payments plus a single future amount payable at maturity.
The price of a bond is therefore the sum of the present value
of the annuity of semiannual interest payments plus the
present value of the single future payment at maturity.
This present value is calculated by discounting at the true
interest rate and assuming semiannual payment periods.
6.4 Present Value of an Annuity; Amortization
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
6.5 Annuities and Amortization
Using Recursive Sequences
Section 6.5 p30
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.5 p31
Often, though, money is invested in equal amounts at
periodic intervals. An annuity is a sequence of equal
periodic deposits. The periodic deposits may be made
annually, quarterly, monthly, or daily.
When deposits are made at the same time that the interest is
credited, the annuity is called ordinary. We will only deal
with ordinary annuities here.
The amount of an annuity is the sum of all deposits made
plus all interest paid.
6.5 Annuities and Amortization Using Recursive Sequences
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.5 p32
Theorem
Annuity Formula
If A
0
= M represents the initial amount deposited in an
annuity that earns a rate of r per annum compounded N
times per year, and if P is the periodic deposit made at each
payment period, then the amount A
n
of the annuity after n
deposits is given by the recursive sequence
A
0
= M, (1)
*We use N to represent the number of times interest is compounded per annum instead
of n, since n is the traditional symbol used with sequences to denote the term of the
sequence.
1
1 , 1
n n
r
A A P n
N
| |
= + + >
|
\ .
6.5 Annuities and Amortization Using Recursive Sequences
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.5 p33
Theorem
Amortization Formula
If $B is borrowed at an interest rate of r per annum
compounded monthly, the balance A
n
due after n monthly
payments of $P is given by the recursive sequence
(2)
Formula (2) may be explained as follows: The initial loan balance is $B.
The balance due after n payments will equal the balance due previously,
plus the interest charged on that amount reduced by the periodic
payment P.
0 1
, 1 , 1
12
n n
r
A B A A P n
| |
= = + >
|
\ .
6.5 Annuities and Amortization Using Recursive Sequences
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Chapter 6 p34
IMPORTANT FORMULAS
Simple Interest Formula I = Prt
Discounted Loans R = L Lrt
Compound Interest Formula
A = Pe
rt
Amount of an Annuity
Present Value of an Annuity
Amortization
6 Summary
Summary
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1 (1 )
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Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Select the best answer
for each of the following
multiple choice questions.
Section 6.MC p35
6.Extra Multiple Choice Questions
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.MC p36
6.Extra Multiple Choice Questions
1. If $15,000 is deposited in an account
that earns interest at a 5.25% annual
rate, compounded monthly, find the
amount in this account after seven
years.
A. $21,610.07
B. $21,460.80
C. $21,644.44
D. $6,644.44
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.MC p37
6.Extra Multiple Choice Questions
2. If $235 is deposited at the end of each
month for five years in an account earning
interest at an annual interest rate of 7.15%,
compounded monthly, find the amount in
this account at the end of five years.
A. $16,265.69
B. $15,108.15
C. $14,100.00
D. $16,889.81
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.MC p38
6.Extra Multiple Choice Questions
3. If an automobile loan of $28,500 is to be
repaid in equal monthly payments over
five years, at an annual interest rate of
3.75%, compounded monthly, find the
monthly payment for this loan.
A. $521.66
B. $475.00
C. $432.60
D. $476.48
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.MC p39
6.Extra Multiple Choice Questions
4. What is the principal amount of a 30-year,
fixed-rate home loan, if the monthly
mortgage payment for this loan is $1800
and the annual interest rate for this loan is
6.125%, compounded monthly?
A. $312,700.30
B. $296,242.39
C. $288,013.44
D. $279,784.48
Finite Mathematics: An Applied Approach by Michael Sullivan
Copyright 2011 by John Wiley & Sons. All rights reserved.
Section 6.MC p40
6.Extra Multiple Choice Questions
Answers for the Multiple Choice Questions
1. C. $21,644.44
2. D. $16,889.81
3. A. $521.66
4. B. $296,242.39