Ordinary Annuity

Ordinary Annuity§

An Ordinary Annuity, also known simply as an annuity, involves a series of equal payments or receipts occurring at the end of each period over a set duration. It’s commonly used in contexts such as mortgage or loan repayments, retirement accounts, and investment portfolios.

Examples§

1. Mortgage Payments: When someone takes out a mortgage, they typically make monthly payments. These payments form an ordinary annuity.
2. Retirement Accounts: Payments made into a retirement account, like an Individual Retirement Account (IRA), often occur at the end of each month or year, forming an ordinary annuity.
3. Bond Coupon Payments: Bonds that pay interest semi-annually at the end of each period represent an ordinary annuity for the bondholder.

Frequently Asked Questions§

Q1: How is an ordinary annuity different from an annuity due?

• A: In an ordinary annuity, payments occur at the end of each period, whereas in an annuity due, payments occur at the beginning of each period.

Q2: What formula is typically used to calculate the present value of an ordinary annuity?

• A: The present value of an ordinary annuity can be calculated using the formula: PV = Pmt × [(1 - (1 + r)^-n ) / r]
  • PV = Present Value
  • Pmt = Payment amount per period
  • r = Periodic interest rate
  • n = Total number of payments

Q3: Can ordinary annuities be used for retirement planning?

• A: Yes, ordinary annuities are commonly used in retirement planning for making or receiving regular payments towards retirement savings.

Q4: What is the future value of an ordinary annuity?

• A: The future value can be calculated using the formula: FV = Pmt × [((1 + r)^n - 1) / r]
  • FV = Future Value
  • Pmt = Payment amount per period
  • r = Periodic interest rate
  • n = Total number of payments

Q5: Are loan repayments examples of ordinary annuities?

• A: Yes, many loan repayments, including mortgages, car loans, and personal loans, are structured as ordinary annuities with payments due at the end of each period.

Related Terms§

• Annuity Due: An annuity where payments occur at the beginning of each period.
• Present Value: The current value of a series of future payments, discounted at a specified interest rate.
• Future Value: The value of a series of payments at a specific future date, including interest.
• Periodic Interest Rate: The interest rate applied to each period in the annuity.

Online Resources§

1. Investopedia: Understanding Annuities
2. Khan Academy: Present Value of Annuities
3. Financial Calculators: Ordinary Annuity Calculator

References§

1. Brealey, R., Myers, S., & Allen, F. (2019). Principles of Corporate Finance. McGraw-Hill Education.
2. Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments. McGraw-Hill Education.
3. Reilly, F. K., & Brown, K. C. (2011). Investment Analysis and Portfolio Management. Cengage Learning.

Suggested Books for Further Studies§

1. The Complete Guide to Annuities: How to Safeguard Your Future by Matthew G. Young
2. Principles of Investments by Bodie et al.
3. Valuation: Measuring and Managing the Value of Companies by McKinsey & Company Inc.

Real Estate Basics: Ordinary Annuity Fundamentals Quiz§