Definition And Examples Of Annuities

Definition And Examples Of Annuities

Annuities are payments of equal amount of money remitted over particular period of time. An annuity is therefore a fixed payment that is made for a specific number of years from one party to another. As a general rule, the term annuity is used to refer to ordinary annuity except when a different form of similar payment is being referred to. This implies that there are different forms of annuities as highlighted below due to the attributes of the payment and computation. In order to determine the specific value of various forms of annuities, there are simple to complex formulae of computation such as compounding.

The complexity of the determination of the preset value of an annuity is usually dependent on the size of the entire value of the annuity. However, there are specific approaches that such computations can be given to solve the complexity issue. When referring to a general annuity, the timing of remittance is usually at the end of the specified unit period. One principle observation in annuities is that they are effected in a series following a specific frequency over the entire duration of remittance. To this end, annuities are treated differently from other forms of payments (Keown et al, 1998).

Give some examples of annuities

There are different types of annuities depending on various aspects of operating the annuity. Apart from a general annuity where remittances occur at the beginning of the year, the other annuities include the following. Firstly, a compound annuity is the type of an annuity where equal amounts of money are remitted for investment or savings purposes at every end of the period and allowing the money to grow. In such an annuity, the determination of the earnings obtained at the end of the savings period composed of the series of deposits can be computed through a mathematical formula. The technique used in this determination is a compounding equation that values the earnings of the distinct deposits until the end of the depositing period. The following formula is applied in the determination of a compound annuity;

FVn of an annuity=PMT[(FVIFi,n-1)/i]

Where FV= future value after growth period

PMT= value of frequent annuity deposits

i=annual interest rate

n=total number of years

Secondly, annuities due are the type of annuities whose actual dates of payments are brought forward by a year. In terms of actual date of remittance of many other forms of payments, it is supposed to occur at the end of every year but it is different in annuities due. The actual date of remitting the payments in annuities due is at the beginning of every payment period instead. It implies that in compounding the value of payments, an additional payment period is added. The following formula is applied;

FVn(annuity due)=PMT[{(1+i)n-1}/i] (1+i)=PMT(FVIFAi,n)(1+i)

Where,

FVIFAi,n= Future-Value Interest Factor for an Annuity (multiplier used to calculate FV)

Distinguish between an annuity and a perpetuity

Whereas an annuity has a specified duration of time during which payments are made, an annuity continues without a particular end. An annuity continues up to the end of the determined period by way of equal payments whereas perpetuity never ends.

Reference

Keown, A.J., & Martin, J.D., & Petty, J.W., & Scott Jr., D. F. (1998). Foundations of finance the logic and practice of financial management, 6th edn. New Jersey. Pearson Education Inc