Definition of Annuity in Advance
An annuity in advance, also known as an “annuity due,” involves a series of equal or nearly equal payments made at the beginning of each period. This is in contrast to an ordinary annuity, where payments are made at the end of each period. Annuities in advance are common in various financial arrangements, including lease agreements, rental payments, and insurance premiums.
In an annuity in advance, each payment is received or paid at the start of the period, which can impact the present value of the annuity since payments are received or obligations are settled sooner.
Examples
- Rental Payments: A rent agreement where the tenant pays rent at the beginning of each month.
- Insurance Premiums: An insurance policy requiring upfront premium payments at the start of the coverage period.
- Leases: Equipment leases requiring payments at the start of each leasing period.
- Subscriptions: Annual magazine subscriptions paid at the start of the subscription period.
Frequently Asked Questions (FAQs)
Q: How is an annuity in advance different from an ordinary annuity?
A: Annuities in advance require payments at the beginning of the period, while ordinary annuities require payments at the end of the period.
Q: What are the advantages of an annuity in advance?
A: The main advantage is that the recipient has access to the funds sooner, potentially enabling earning interest on the received payments earlier.
Q: How is the present value of an annuity in advance calculated?
A: The present value of an annuity in advance is calculated by summing the discounted values of each payment, discounted back to the start date.
Q: Can annuities in advance be used for retirement savings?
A: Yes, annuities in advance can be structured for retirement savings, often offering payments at the start of each period during retirement.
- Ordinary Annuity: An annuity with payments made at the end of each period.
- Present Value: The current value of a series of future payments, discounted at some appropriate interest rate.
- Future Value: The value of a series of present payments compounded over time at a given rate of interest.
- Lease Agreement: A contractual arrangement detailing the terms under which one party agrees to rent property from another party.
- Discount Rate: The interest rate used to discount future cash flows to their present values.
Online Resources
References
- Bodie, Zvi, Alex Kane, and Alan J. Marcus. “Investments.” McGraw-Hill Education, 2017.
- Fabozzi, Frank J. “Fixed Income Analysis.” Wiley, 2015.
- Reilly, Frank K., and Keith C. Brown. “Investment Analysis and Portfolio Management.” Cengage Learning, 2012.
Suggested Books for Further Studies
- Solomon S. Huebner, Kenneth Black Jr., and Harold D. Skipper, Jr., “Life Insurance, 13th Edition.”
- Jane Bryant Quinn, “How to Make Your Money Last: The Indispensable Retirement Guide.”
- Moshe A. Milevsky, “The Calculus of Retirement Income: Financial Models for Pension Annuities and Life Insurance.”
Real Estate Basics: Annuity in Advance Fundamentals Quiz
### What distinguishes an annuity in advance from an ordinary annuity?
- [ ] Payments are variable from period to period.
- [x] Payments are made at the beginning of each period.
- [ ] Payments are unequal.
- [ ] Payments are made sporadically.
> **Explanation:** An annuity in advance involves payments made at the beginning of each period, as opposed to the end of each period for an ordinary annuity.
### In a rental agreement structured as an annuity in advance, when is the rent payment typically due?
- [x] At the beginning of each month
- [ ] At the end of each month
- [ ] Midway through the month
- [ ] Infrequency determined each period
> **Explanation:** In an annuity in advance rental agreement, the rent payment is typically due at the beginning of each month.
### What is another name for an annuity in advance?
- [ ] Future annuity
- [ ] Deferred annuity
- [x] Annuity due
- [ ] Irregular annuity
> **Explanation:** An annuity in advance is also commonly referred to as an "annuity due."
### Why can the present value of an annuity in advance be greater than an ordinary annuity?
- [ ] Payments inclusively start from the money inflow season
- [x] Payments are received or paid sooner providing earlier access to funds
- [ ] Higher interest rates apply
- [ ] Lower interest rates apply
> **Explanation:** The present value of an annuity in advance can be greater as payments are received or paid at the start of each period, providing earlier access to funds.
### Which feature characterizes a lease agreement annuity in advance?
- [ ] Payments vary each period based on usage
- [x] Payments are made at the start of each leasing period
- [ ] Payments are deferred to the end of the lease
- [ ] Payments equate to asset depreciation
> **Explanation:** In a lease agreement annuity in advance, payments are made at the start of each leasing period.
### How does an annuity in advance affect the cash flow for the recipient?
- [x] Provides earlier access to funds
- [ ] Delays recipient's access to funds
- [ ] Has no effect on cash flow timing
- [ ] Results in less overall cash flow
> **Explanation:** An annuity in advance provides the recipient with earlier access to the payments, affecting the cash flow timing positively for the recipient.
### Which typically does not represent an example of annuity in advance?
- [ ] Monthly rental agreements
- [ ] Annual insurance premiums
- [ ] Lease agreements
- [x] Corporate bond interest payments
> **Explanation:** Corporate bond interest payments are typically made at the end of each period (ordinary annuity), not at the beginning.
### What affects the present value of an annuity in advance the most?
- [ ] The frequency of payments
- [x] The timing of each payment
- [ ] Variable interest rates
- [ ] Type of agreement (lease, rent)
> **Explanation:** The timing of each payment being made at the beginning of the period rather than the end significantly impacts the present value of an annuity in advance.
### Which annuity type potentially results in higher earnings due to access to funds?
- [ ] Deferred annuity
- [ ] Future annuity
- [x] Annuity in advance
- [ ] Irregular annuity
> **Explanation:** An annuity in advance potentially results in higher earnings due to access to funds earlier in the period.
### How can an annuity in advance be used in retirement planning?
- [ ] Provides irregular payments upon request
- [ ] Delays all payments
- [x] Provides regular payments at the start of each period for smoother cash flow management
- [ ] Accumulates all payments for distribution at term end
> **Explanation:** An annuity in advance can provide regular payments at the start of each period during retirement, leading to smoother cash flow management.
