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Definition of Terms:

Payments may be made annually, semi-annually, quarterly, or at other periods

Some examples of annuities are:

1) monthly payments of rent,

2) weekly wages,

3) annual premiums on a life insurance policy,

4) periodic pensions,

5) periodic payments on installment purchases, and

6) semi-annual interest payments on a bond.

Annuities are classified into annuity certain and contingent annuity:

Installment payments are an annuity certain.

2) A contingent annuity is an annuity whose payments depend upon an event

cannot be foretold accurately. Life insurance premiums are an example of

contingent annuity, because the payments ends at the death of the insured.

an insured would die is uncertain.

1) The payment interval is the time between successive payments of an ann

2) The term of an annuity is the time between the first payment interval and

last payment interval.

3) The periodic payment, denoted by R, is the amount of each payment.

4) Simple annuity is an annuity in which the payment interval is the same as

interest period.

There are 3 kinds of annuities certain, namely:

a) Ordinary Annuity

b) Annuity Due

c) Deferred Annuity

In an ordinary annuity, payments are made at the end of each payment inter

Diagram: (R = periodic or regular payment)

4

TERM

R

n1

n(periods)

In an annuity due, payments are made at the beginning of each payment int

Diagram: (R = periodic or regular payment)

R

0

R

n1

n(periods)

TERM

A deferred annuity is an annuity in which the first payment is made at some

time, as shown in this diagram:

no payments

for d periods

0

2

d-1

d

d+1 d+2

n +(d-1) n +d (per

payments for n periods

1. Amount of an Ordinary Annuity:

is the value at the end of the term

The amount of an ordinary is the value on the last payment date

is the sum of the accumulated payments

annuity, denoted by S,

at the end of term.

For instance,

for 4 years when money is worth 5%, accumulate the payment of each peri

to the end of 4 years, then add the accumulations.

TERM

1,000

1,000

0

1,000

1,000

2

3

4

1000

= 1000

1000(1+0.05) = 1,050

1000 = 1,102.5

1000 = 1,157.625

S = 4,310.125

Let: S = amount of an ordinary annuity at the end of n periods

R = periodic payment or periodic rent

n = number of periods or payments

i = rate per conversion period

TERM

0

R

1

R

2

R

n-2

R

n-1

R

n (periods)

R

R(1+i)

R

R

R

S = sum of the accumulated values of R at the end of the term

S = R + R(1+i) + R+ + R+ R (equation1)

Multiplying equation1 by (1 + i), we get

(1+ i)S = R(1+i) + R+ + R+ R

(equation 2)

Subtracting equation 1 from equation 2, we get

(1+i)S S = R - R

Solving for S: (SEE NEXT SLIDE)

Formula:

The present value of

an ordinary annuity,

denoted by A,

is the value one period before the first paymen

is the sum of discounted payments at the

beginning of the term

For example, to find the present value of an annuity, discount each payment,

add the results, as shown in the diagram.

TERM

1,000

1,000

1,000 1,000

0

1

952.3809 = 1,000

905.0294 = 1,000

863.8376 = 1,000

822.7024 = 1,000

A = 3,545.9505

In deriving

the formula for the present value, we use the fact that A is the pre

value of S due in n periods.

n periods

S

A

0

n1

From the previous formulas, notice that A and S are related to the equations

S=A

A=S

Hence, A = S

=

=

=

The

formulas for the amount S and present value A

of

ordinary annuity:

A=

Note: These formulas are applicable only when the

payment interval is the same as the interest period.

Example 1: Find the amount and the present value

of an ordinary annuity of 250 each quarter

payable for 5 years and 9 months, if money is

worth 12% compounded quarterly.

Example

1: Find the amount and the present value of an ordinary

annuity of

250 each quarter payable for 5 years and 9 months, if money is

worth 12%

compounded quarterly.

Solution:

Given: R = 250

j = 0.12

t = 5 years

m=4

i = j/m = 0.03

n = mt = 23 periods

Find: S and A

= 250(32.452883) = 8,113.22

A = = 250 = 250(16.443608) = 4,110.90

30,000 down and 5,000 each month for 5 years. If money is worth 12%

compounded monthly, find the cash price of the car.

Solution:

Cash price = downpayment + present value of the installment payments (the a

= downpayment + present value of 60 monthly payments at 5,00

Cash price = 30,000 + A

= 30,000 + 5,000

= 30,000 + 5,000(44.955038)

= 254,775.19

compounded monthly.

Assignment:

Page 55, item: 6

Page 58, items: 1 and 5

If the present value or the amount of an annuity is known, the periodic pay

can be determined by solving the annuity formulas for R. Hence, we have

and

A=

compounded quarterly in order to have 25,000 in 8 years?

compounded quarterly in order to have 25,000 in 8 years?

Solution:

Given: S = 25,000

t = 8 years

n = 32 periods

i = 0.12/4 = 0.03

Find : R

= 476.17

8 monthly payments. If money is worth 24% compounded monthly, find the

monthly payment.

Example 3: A man borrows 10,000. He agrees to pay the principal and inte

paying a sum each year for 4 years. Find his annual payment if he pays inte

8 % compounded annually.

Assignment:

Page: 61

Item: 1, and 8

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