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Definition
An annuity is a series of payments required to be made or received over time at regular intervals.
The most common payment intervals are yearly (once a year), semi-
annually (twice a year), quarterly (four times a year), and monthly (once a month).
Some examples of annuities: Mortgages, Car payments, Rent, Pension fund payments, Insurance
premiums.
TYPES OF ANNUITIES
Ordinary Annuity:
An Ordinary Annuity has the following characteristics:
For calculating the sum of a series of regular payments the following formula should be used:
R[(1+i)^ n -1]
S n = —————–
i
Example: Alan decides to set aside $50 at the end of each month for his child’s college
education. If the child were to be born today, how much will be available for its college
education when s/he turns 19 years old? Assume an interest rate of 5% compounded monthly.
Solution:
First, we assign all the terms:
R= $50
i= 0.05/12 or 0.004166
n= 18 x 12, or 216
Now substituting into our formula, we have:
R[(1+i)^n-1]
S n = ——————-
i
$50[(1+0.05/12)^216 -1]
S n = ——————————–
0.05 / 12
S n = $50(349.2020206)
S n = $17,460.10
R[1-(1+i)^-n]
A n = ——————–
i
Example: Alan asks you to help him determine the appropriate price to pay for an annuity
offering a retirement income of $1,000 a month for 10 years. Assume the interest rate is 6%
compounded monthly.
Solution:
Substituting into our formula, we have:
R = $1,000
i = 0.06 /12 or 0.005
n = 12 x 10, or 120
$1,000[1-(1+0.005)^-120]
A n = ———————————–
0.005
A n = $90,073.45
Annuity Due:
In an annuity due, the payments occur at the beginning of the payment period.
For calculating the sum of a series of regular payments the following formula should be used:
R(1+i)[(1+i)^ n -1]
S n (due)= ———————–
i
Example: Alan wants to deposit $300 into a fund at the beginning of each month. If he can earn
10% compounded interest monthly, how much amount will be there in the fund at the end of 6
years?
Solution:
R = $300
i = 0.10/12 or 0.008333
n = 12 x 6 or 72
$300(1+0.10/12)[(1+0.10/12)^72-1]
S n (due) = ————————————————-
0.10/12
S n (due) = $300(98.93)
S n (due) = $29,679
R(1+i)[1-(1+i)^-n]
A n(due) = ————————-
i
Example: The monthly rent on an apartment is $950 per month payable at the beginning of each
month. If the current interest is 12% compounded monthly, what single payment 12 months in
advance would be equal to a year’s rent?
Solution:
R= $950
i= 0.12/12 or 0.01
n= 12
$950(1+0.03)[1-(1+0.01)^-12]
A n(due) = ———————————————-
0.01
A n(due) = $950(11.37)
A n(due) = $10,801.50
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This has been helpful for me. Please show more example problems.
Reply
2. Skener says:
Can you explain how did the first problem became 18 as your n where the child is 19
years old?
Reply
1. god is good says:
s/he will set aside until 18 years, the 19th year will not be included since it’s the time
s/he will get the money.
Reply
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