Lesson 3: Annuities

• Annuity – a sum of money that is paid in regular equal payments.

Example:
Installment payments, monthly rentals, and life insurance premiums are annuities.

• Payment Interval – the period of time between consecutive payments.

Example:
Ged buys a new smartphone and agrees to pay it via installment. He will pay ₱1 500 every month for 2 years.
In this case, the payment interval of the annuity is monthly.

• Term – the time from the beginning of the first payment interval to the end of the last payment interval.
Example:
Ged buys a new smartphone and agrees to pay it via installment. He will pay ₱1 500 every month for 2 years.
In this case, the term of the annuity is 2 years.

Types of Annuity Based on Payment Duration

1. Annuity Certain
- It is an annuity payable for a definite duration. It means that this annuity begins and ends on a definite date.
Example:
Arya buys a new laptop and agrees to pay through installment. She will pay ₱2 500 every month for 2 years.

2. Perpetuity
- It is an annuity payable over a term that has a definite start date but no definite end date.
Example:
Payment of housing rent is a perpetuity.

3. Contingent Annuity
- It is an annuity payable for an indefinite duration. It means that the beginning or the termination is dependent
on some certain event.
Example:
Insurance and pension payments are contingent annuities.

Kinds of Annuity Certain

1. Simple Annuity
- It is an annuity certain whose compounding period is the same as the payment interval.
Example:
Leonard buys a brand-new TV with installment payment at the end of each month with interest compounded
monthly.

2. General Annuity
- It is an annuity certain whose compounding period is not the same as the payment interval.
Example:
Sheldon buys a brand-new TV with installment payment at the end of each quarter with interest compounded
annually.

Types of Annuity Based on Time of Periodic Payment

1. Ordinary Annuity
- It is an annuity in which the periodic payment is made at the end of each payment interval.
Example: Sam buys a washing machine with an installment payment at the end of every month for one year.

2. Annuity Due
- It is an annuity in which the periodic payment is made at the beginning of each payment interval.
Example: Gilly buys a washing machine with an installment payment at the beginning of every month for one year.
• Fair Market Value (FMV) – the price that two parties are willing to pay for an asset or liability, given the
following conditions:
- Both parties are well-informed about the condition of the asset or liability.
- Neither party is under undue pressure to buy or sell the item.
- There is no time pressure to complete the deal.
Example:
Suppose you want to sell a car for ₱500 000. A buyer offers to purchase the car at a lower price of ₱420 000.
If you and the buyer agreed on ₱450 000 after negotiating the price, then the fair market value of the car is ₱450 000.

• Deferred Annuity – an annuity in which the first payment interval is delayed or deferred for a period of time.
- In a deferred annuity, the time interval to the beginning of the first payment interval is called the period of
deferral.
Example:
‘A loan with an interest rate of 7% and a quarterly payment of ₱5 000 for 3 years starting at the end of 1
year’ is an example of a deferred annuity since the phrase starting at the end of 1 year indicates that the payment
started on a later date.
At the end of 1 year will be at time 4, if one quarter is considered as one period. Hence, the period of deferral
is from time 0 to time 3 which is equivalent to 3 quarters.