Simple Annuities

Definition of Terms:

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

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:

1) An annuity certain is an annuity in which payments begin and end at fixed t

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.

Other terms are:

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 h periods
0

2
h -1
h
h +1
payments for n periods

R
h+2

n +(h -1) n +h (pe

i. Ordinary
Annuity
Amount of an Ordinary Annuity:
The amount of an ordinaryis the value at the end of the term
is the value on the last payment date
annuity, denoted by S,
is the sum of the accumulated payments
at the end of term.

For instance, to find the amount of a 1000 ordinary annuity, payable annua
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

Derivation of Ordinary Annuity Formulas:

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:

Present Value of an Ordinary Annuity

The present value of
an ordinary annuity,
denoted by A,

is the value at the beginning of the term,

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

Example 2: A car was purchased under these terms:

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

Example 3: Find the amount of an annuity of 2,500 a month for 15 years at 8%

compounded monthly.
Assignment:
Page 55, item: 6
Page 58, items: 1 and 5

Finding the Periodic Payment of an Ordinary Annuity.

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=

Example 1: What sum must be deposited every 3 months in a fund paying 1

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

Example 1: What sum must be deposited every 3 months in a fund paying 12

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

Example 2: A dress costs 500. It is purchased with a downpayment of 20

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
Items: 1, and 8

Example 2: A dress costs 500. It is purchased with a downpayment of 20

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

Solution:
Given: A = 500 200 = 300
=
n=8
= 40.95
i = 24%/12 = 2%
Find: R

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.

Solution:
Given: A = 10,000
=
J = 0.08
= 3,019.21
m=1
t=4
n=4
Find: R

ii. Annuity Due

An annuity due is an annuity, as earlier defined, paid at the beginning of the p

interval. House rent is an example of an annuity due.
The present value of annuity due is its value on the first payment date. It will
denoted by A(due).
Annuity due of n payments
A(due)
R
R
R
R
R
0

n-2

n1

n(periods)

From the diagram, we can produce an ordinary annuity of (n 1) payments wh

term begins at 0. The (n 1) payments exclude the first payment. The diagra
below shows the ordinary annuity.
R
0

R
2

n2

n1

ordinary annuity of (n 1) payments

n (periods)

The ordinary

annuitys present value plus the first payment at 0 is the present

of the annuity due. This lead to the formula:
A(due) = (first payment) + (present value of ordinary annuity of (n-1) paym
A(due) = R +
=
The amount of an annuity due is its value one period after the last payment.
It will be denoted by S(due).

Annuity due of n payments

S(due)
R
R

0
1
2
n-2
n1
n(periods)
To find S(due) we again produce an ordinary annuity of (n+1) payments of R.
Rs term ends one period after the annuity dues last payment. Diagram of th
ordinary annuity:
R
R
R
-1

n1

ordinary annuity of (n + 1) payments

R
n (periods)

The ordinary

annuity amount of (n+1) payments, includes a final payment

(encircled in the diagram). In the annuity due, no such payment is made. He
one payment must be subtracted from the ordinary annuity amount to get t
annuity due amount. Thus, the formula is obtained
S(due) = amount of ordinary annuity of (n+1) payments - R
S(due) = - R
=

Formulas:
A(due)= ,

to find the present value of annuity due

S(due) = , to find the amount of annuity due

R=

and R = , to find the periodic payment R

Example 1: The amount rent of a house is 9,000 payable at the beginning o

month. If money is worth 12% compounded monthly, what is the cash equ
of 5 years rent?
Solution:
Given: R = 9,000
t=5
m = 12
n = 60
i = j/m = 1%
Find: A(due)
A(due) = R +
= 9,000 + 9,000
= 9,000+ 9,000(44.404589)
= 408,641.30

Example 2: What sum should be invested at the beginning of each quarter,

16% compounded quarterly, in order to have 25,000 in a fund in 10 year
Solution:
Given: S(due) = 25,000
i = j/m = 4%
t = 10
m=4
n = 40
Find: R
R=
=
=
=
= 252.97

Example 3: Mike deposits 780 at the beginning of each year at 6.5% compo
annually. How much money does he have in 8 years?

Example 4: A camera can be purchased on 10 monthly payments of 150 ea

The first payment is due on the day of purchase. Find the equivalent cash pr
if money is worth 18% (m = 12).

Assignment:
Page: 70 , items: 2 and 7; Topics: Find the amount and present value of annu

iii. Deferred Annuity

A deferred annuity is an annuity in which the first payment is made at some
time, as shown in this diagram. (See the diagram below)

The length of time for which there are no payments is called the period of
deferment. The first payment is made one period after the period of deferme
Therefore, if an annuity is deferred for 7 periods, the first payment is made o
8th period and if the first payment is made at the end of 15 periods, the annu
is said to be deferred for 14 periods.
no payments
for h periods
0

2
h -1
h
h+1
payments for n periods

R
h+2

n +(h-1) n +h (per

Let A(def)
be the present value of the deferred annuity.
A(def) = (present value of (n + h) payments) (present value of h payments)
=
=
The payment R is:

R= periodic payment or rent

n = number of periodic payments
i = periodic rate of interest
h = number of periods the annuity
is deferred
A(def) = present value of deferred annuit
Example 1: Find the present value of 10 payments at 100 each, if the first pa
is due at the end of 3.5 years and if money is worth 12% compounded
semi-annually.
=

Example1: Find the present value of 10 payments at 100 each, if the first p
is due at the end of 3.5 years and if money is worth 12% compounded
semi-annually.
Solution:
Given: n = 10, R = 100, h = 6, i = j/m = 0.06, Find : A(def)
Diagram:
h=6
6 payments to be missed
100 100 100 100 100 100 100 100 100 100
0

n = 10
10 payments to be made
A(def) =
= 100
= 100(10.105895 4.9173243)
= 518.86

8(years


Example
2: Find the present value of 10 semi-annual payments of
500 each if the
first is due at the end of 4.5 years and money is worth 10%
converted
semi-annually.
A deferred annuity problem can also be solved as an ordinary
annuity problem.
Discounting can be used to find its present value.
Diagram:
8 payments to be missed
A(def)
A 500 500 500 500 500 500 500
500 500 500
0

1
9(years)

Ordinary annuity of 10
payments
th

Anothersolution:
Given: h = 8, n = 10
A(def) =
= 500
= 500(11.689587 6.4632126)
= 2,613.19

Example 3: A cellphone costs 6,000. A buyer will pay 2,000 now and pa
balance in 8 annual payments. The first payment is due in 5 years. If mon
worth 8% effective, how much is the annual payment?

Example 3: A cellphone costs 6,000. A buyer will pay 2,000 now and pay
balance in 8 annual payments. The first payment is due in 5 years. If mone
worth 8% effective, how much is the annual payment?
Solution:
Given: A(def) = 6,000 2,000 = 4,000
n = 8 (number of payments to be made)
d = 4 (number of payments missed)
i = 0.08
Find: R
h=4
A(def)
0

6
7
8
9
10
11
ordinary annuity of 8 payments

First, accumulate A(def) for 4 periods to get A.

A = A(def)

Then solve for R:

=
= =946.98
= 4,000(1.360489)
= 5,441.956

R
12(years)

Anothersolution:

Example 3: A cellphone costs 6,000. A buyer will pay 2,000 now and pay
balance in 8 annual payments. The first payment is due in 5 years. If mone
worth 8% effective, how much is the annual payment?
Solution:
Given: A(def) = 6,000 2,000 = 4,000
n = 8 (number of payments to be made)
d = 4 (number of payments missed)
i = 0.08
Find: R
=
=
=
= 946.98

Example 4: Find the present value of a 200 annuity payable annually for 5 y
but deferred 3 years, if money is worth 7%.
Example 5: A house and lot can be bought for 500,000 downpayment and
quarterly payments of 8,000 each. The first installment is due at the end
5 years and 3 months. If money is worth 12% compounded quarterly, how
is the cash value of the house and lot?

Example 6: On July 19, 2011, Dong deposited 20,000 in a savings accoun

paying 9% compounded semi-annually. Dong planned to make 10 semi-an
withdrawals starting July 19, 2013. Find the amount of each withdrawal.