Lecture 3: Annuity

Annuity A sequence of equal payments made at equal periods of time is called an annuity. Ordinary annuity If each payment is made at the end of a period, and if the frequency of payments is the same as the frequency of compounding, the annuity is called an ordinary annuity. Payment period The time between payments Term The time from the beginning of the rst period to the end of the last period.

Lecture 3: Annuity

Sinking fund is an ordinary annuity set up to receive periodic payments (including compounded interest) to pay a loan at a future time. If the loan is at the beginning of the term with a present value, the annuity is called an amortization.

Lecture 3: Annuity

Let R be the payment and i is the eective rate of interest for each period. Then Future value at the end of the term (of n periods) is (1 + i)n 1 FV = R i Present value 1 (1 + i)n PV = R i

Lecture 3: Annuity

Example When she is 30, Sue starts making annual deposits of $2,000 into a bond fund that pays 8% annual interest compounded continuously. Assuming that her deposits are made as an ordinary annuity, how much money will be in her account if she retires at age 55? (1.08)25 1 F V = 2000 = $146211.88 0.08 Total deposits is 25($2000)=$50000 Question Assuming that her deposits are made as a continuous income ow, how much money will be in her account at age 55? and what is the total money ow?

Lecture 3: Annuity

Answer
25

FV = e

0.08(25) 0

2000e0.08tdt

1 0.08(25) (e 1) 0.08 = 25000(e2 1) = 159726.40 = e0.08(25)(2000) and the total money ow is

25

2000dt = 50000
0

Lecture 3: Annuity

QUIZ
1 Find the present value of an annuity which pays $500 at the end of each half-year for 20 years if the rate of interest is 9% convertible semiannually. 2 Jack needs $10000 in 8 years. What amount should he deposit at the end of each quarter at 16% interest compounded quarterly to accumulate the $10000?

Lecture 3: Annuity

Exercises
1 If a college freshman invests a $10000 gift at 8% per annum convertible quarterly, how much can be withdrawn at the end of every quarter to use up the fund exactly at the end of four years of college? 2 The price of a car is $10000. The nancing is 18% convertible monthly and the buyer will pay $250 at the end of each month for four years. Find the down payment that will be necessary. 3 A lottery winner is paid a million dollars as an ordinary annuity in 20 years ($50000 for each payment at the end of each year). Find the present value of the prize if interest is 6% compounded continuously. 4 Leslie buys a new car costing $16000. She agrees to pay at the end of each month for 4 years. If interest is 12% compounded monthly, what is the payment each month? Find the total interest Leslie will pay

Lecture 3: Annuity

Homework
1 Pat deposits $12000 at the end of each year for 9 years in an account paying 8% interest compounded annually. Find the nal amount 2 Bill wants to accumulate $100000 for retirement at the end of 12 years. How large should each deposit be at the end of each year? if the nal payment is made one year before the end of the investment period and interest is 7% eective? 3 An annuity provides a payment of n at the end of each year for n years. The annual eective interest rate is 1/n. Find the present value of it 4 Find the monthly payment necessary to amortize a loan of $170892 at 8.11% (annual) interest for 30 years. Find the unpaid balance after 5 years 5 $25000 is deposited at 6% interest compounded annually. A same amount will be withdrawed at the end of each year. Find the amount of each withdrawal so that the money is gone after exactly 8 years