UNIVERSITY OF SARAJEVO

SCHOOL OF ECONOMICS AND BUSINESS SARAJEVO

ANNUITIES IN FINANCIAL MATHEMATICS

SEMINAR PAPER

Course: Quantitative Models in Finance

Mentors: Prof. dr Jasmina Selimović and Senior TA dr Tea Mioković Polić
Students: Džejlana Harbaš
Index no: 76771
Financial Management and Marketing Management

Melika Mundžić
Index no: 76616
Financial Management and Marketing Management

Sarajevo, November 27th 2022.

 CONTENTS

1. INTRODUCTION...............................................................................................1

2. BASIC ANNUITIES...........................................................................................2

2.1. Annuity due........................................................................................................2

2.2. Annuity immediate.............................................................................................3

2.3.Deferred annuities...............................................................................................4

3. GENERAL ANNUITIES....................................................................................4

3.1.Annuities payable less frequent than interest is compounded............................5

3.2.Annuities payable more frequent than interest is compounded..........................7

3.3.Geometric and arithmetic progression................................................................9

3.4.Perpetuities........................................................................................................10

4. ANNUITIES RECEIVABLE............................................................................11

4.1.Immediate annuities receivable.........................................................................11

4.2.Annuities due receivable...................................................................................12

4.3.Annuities receivable more frequent than interest is compounded....................13

4.4.Annuities receivable less frequent than interest is compounded......................15

4.5.Annuities receivable varying in accordance with arithmetic or geometric

progression..............................................................................................................16

5. CONCLUSION.................................................................................................18

REFERENCES........................................................................................................19

TABLE OF FIGURES............................................................................................20
1. INTRODUCTION

An annuity is a series of payments made at equal intervals of time. (Kellison, 2009) Annuities
can be bought through making a single payment or a series of payments. The purpose of buying
an annuity is to recieve a certain amount of payout, which can also be in the form of a single
lump-sum payment or a series of payments through a period of time. Some examples of annuities
include house or mortgage payments, as well as interest payments on invested money. (Kellison,
2009)

Through this paper we hope to explain the topic of annuties in an understandable and simple
manner. Annuities are a common thing in today's world and can be very useful, therefore it is
important that we get acquainted with the concept of them and how they work.

This paper starts with explaining basic annuities due and immediate, after which we move on to
general annuities for which the payment periods and interest compounding periods are not the
same, and we finish off with analyzing annuities receivable. Each section includes timelines
representing the various types of annuities as well as examples of solving annuity-related
problems.

The main sources of information that we have used in the creation of this paper are the textbooks
Theory of Interest by Stephen G. Kellison and Finansijska matematika by dr Branko Trklja.
Other sources of information such as scientific articles and journals were also used.

The significance of annuities in financial mathematics is vast. It is crucial to understand annuities

in order to fully understand the scope of the science that is financial mathematics.

1
2. BASIC ANNUITIES

In the context of financial mathematics, annuities are temporary payments made in equal time
intervals and in equal amounts, or amounts that are increasing or decreasing according to some
mathematical principle. (Trklja, 2008) If any of those characteristics is not satisfied , then the
financial transaction cannot be defined as an annuity.

There are different types of annuities and the most basic distinction is between annuties-certain
and contingent annuities. Annuities-certain are those for which payments are certain to be made
for a fixed period of time. That fixed period of time is referred to as the term of the annuity.
However, if payments are not certain to be made, then we are dealing with a contingent annuity.
In this paper we will be focusing on annuties-certain. (Kellison, 2009)

A payment period is a term used to define the interval between annuity payments. (Kellison,
2009) The payment period does not have to equal the interest conversion period, however as we
are talking about basic annuities for now, the payment period and conversion period will be
equal in the following examples.

Annuities can be paid yearly, semiannually, or in some other time interval. The payments can be
made at the end or at the beginning of a period. If payments are made at the end of a period, that
annuity would be defined as an immediate annuity. If payments are made at the beginning of a
period, then we would call that an annuity due. (Trklja, 2008)

2.1. Annuity due

An annuity due is an annuity whose payments are made at the beginning of each period. The
term of this kind of annuity starts at the time of the first payment (today) and ends one payment
period after the last payment is made. (Giuseppe Campolieti, 2014)

2
Figure 1: Timeline depicting annuities due.

In the picture above is a timeline which represents 15 annual payments made at the end of each
year, denoted with u1. The blue dots represent the moment of interest conversion. With annuities
due payable we use the third financial table.

Due: K n = u × III np (Trklja, 2008)

Let' suppose with given timeline that we have an annuity of 100KM invested at the beginning of
every year with annual interest rate of 7% (d).

K n = u × III np

K 15 = 100 × III 15
7

K 15 = 100 ×26.888053551

K 15 = 2,688.8053551

2.2. Annuity immediate

Consider you make payments at the end of the year for some number of years. We would call
that an immediate annuity. (Olivier, 2021) The term of this kind of annuity starts one period
before the first payment and ends on the date of the last payment. (Giuseppe Campolieti, 2014)

Figure 2: Timeline depicting annuities immediate.

3
In the picture above, we can observe a timeline with 15 annual payments made at the beginning
of each year, denoted with u1. The blue dots represent the moment of interest conversion. For the
annuities immediate we use the formula:

K ' n = u ×(1+ III n−1

p ) (Trklja, 2008)

We will use the same example as before:

K n = u ×(1+ III n−1

p )

K 15 = 100 ×(1+ III 15−1

7 )

K 15 = 100 ×(1+ 24.129022010)

K 15 = 100 ×25.129022010

K 15 = 2,512.902201

2.3. Deferred annuities

An annuity whose first payment is made after the end of the first interest period is called a
deferred annuity. We can say that a deferred annuity's term is deferred for k periods. (Giuseppe

Campolieti, 2014) For the deferred annuities the formula used is K n ¿ u × ( 1+ III p ) × I p (Trklja,
n−1 m
m

2008)

3. GENERAL ANNUITIES

General annuities are those for which the payment periods and interest compounding periods are
not the same. Payments could be made more or less frequently than interested is compounded. In
order to solve a problem involving general annuities, we must adjust our given interest rate so

4
that it becomes an equivalent rate for which the interest compounding period is the same as the
payment period. After doing that, a general annuity problem is transformed into a regular annuity
problem. (Giuseppe Campolieti, 2014)

3.1. Annuities payable less frequent than interest is compounded

With this type of annuity, we will have less payments and more compounding. This type of
annuity can be immediate or due.

Figure 3: Timeline depicting annuities due payable less frequent than interest is compounded.

The formula for annuities due payable less frequent than interest is convertible:

( )
mn+ m
III p
K mn=u × m
−1 (Trklja, 2008)
III p

The formula for immediate annuities payable less frequent than interest is compounded:

mn
III p
K ' mn=u × m (Trklja, 2008)
III p

In this example we have a payment of 100KM being made at the beginning of every year for 15
years. Interest is 7%(d) and it is converted semianually.
Figure 4: Timeline depicting immediate annuities payable less frequent than interest is compounded.

U=100

5
P=7%

n=15

m=2

K nm=?

( III mn+
)
m
p
K mn=u × m
−1
III p

K 30=100 ×
( III 32
3,5

III 27
−1
)
K 30 =100 × ( 59.341210053
2.214900000
−1 )

K 30 = 2,579.1823582555

Same but it is paid at the end of the year

U=100

p=7%

n=15

m=3

K ' mn=?

mn
III p
K ' mn=u × m
III p

III 37 × 15
K ' 45 =100×
III 37

45
III 7
K ' 45 =100× 3
III 7

6
3.2. Annuities payable more frequent than interest is compounded
With this type of annuity, we will have less payments and more compounding. Just like the
previous type, this type of annuity can also be due or immediate.

Figure 5: Timeline depicting annuities due payable more frequent than interest is compounded.

The formula for annuities due payable more frequent than interest is compounded:

K nm=u × m+ [ p ( m+1 )
200 ]
× ( 1+ III n−1
p ) (Trklja, 2008)

Figure 6: Timeline depicting immediate annuities less frequent than interest is compounded.

The formula for immediate annuities less frequent than interest is compounded:

K ' nm=u × m+[ p ( m−1 )

200 ]
× ( 1+ III n−1
p ) (Trklja, 2008)

For this example we have invested 100 KM every semester for 15 years. Interest rate is
converted annually and it amounts to 7% (d). Let's do this for both due and immediate.

Due:

U=100

P=7%

7
n= 15

m=3

K nm=?

[
K nm=u × m+
p ( m+1 )
200 ]× ( 1+ III n−1
p )

K 45=100× 3+ [ 7 ( 3+1 )
200 ]× ( 1+ III 7 )
15−1

K 45=100× 3+
[ 28
200 ]
× ( 1+ 24.129022010 )

K 45=100× 3+ [ 28
200 ]
× ( 1+ 24.129022010 )

K 45=100× 3.14 ×25.129022010

K 45=¿7,890.51291114

Immediate:

U=100

p=7%

n=15

m=2

K nm=?

[
K ' nm=u × m+
p ( m−1 )
200 ]
× ( 1+ III n−1
p )

K ' 30=100 × 2+ [ 7 ( 2−1 )

200 ]
× ( 1+ III 7 )
15−1

K ' 30=100 × 2+ [ 7 ( 2−1 )

200 ]
× ( 1+24.129022010 )

8
K ' 30=100 × 2+ [ 28
200 ]
× ( 1+24.129022010 )

K ' 30=100 ×2.14 ×25.129022010

K ' 30=5,377.61071014

3.3. Geometric and arithmetic progression

So far, we have talked about annuities with level payments. However, payments can, in some
cases, vary over time. Annuities can have payments varying according to arithmetic or geometric
progression.

If we consider an immediate annuity in which the first payment is u and each following payment
increases by an amount Q, then we are dealing with an arithmetic annuity. (Wai-Sum Chan,
2017)

The formulas for arithmetic annuities are:

Due:

100 d
× ( III p−n × I P ) (Trklja, 2008)
n n 1
K n=u1 × III p ±
p

Figure 7: Timeline depicting an arithmetic annuity.

Immediate:

100 d
K ' n =u1 × ( 1+ III n−1
p )± × ( 1+ III n−1
p −n ) (Trklja, 2008)
p

9
If we consider an immediate annuity in which the first payment is u and each following payment
increases by a factor of (1+k), that is, each payment is k×100% larger than the previous, then we

are dealing with a geometric annuity. (Wai-Sum Chan, 2017)

Figure 8: Timeline depicting a geometric annuity.

The formulas for geometric annuities are:

Due:

r ( r −q )
n n
K n=u1 × or
r−q

r ( q n−r n)
K n=u1 ×
q−r

Immediate:

n n
r −q
K ' n =u1 or
r−q

q n−r n
K ' n =u1
q−r

3.4. Perpetuities
A perpetuity is a special kind of annuity. The payments begin on some fixed date but do not have
an end date; that is, they go on forever. This type of annuity is also called a continuous annuity.
(Kellison, 2009) One examaple of perpetuities from real life is in the real-estate sector. If
someone buys a property and then rents it out, they can expect an infinite stream of payments

10
from the renter as long as the property continues to exist and the renter continues to rent it. (CFI,
2022)

4. ANNUITIES RECEIVABLE

An annuity receivable is a right to a scheduled payment or a fixed income secured by the

payment of a capital sum. (Reuters, 2022) Just like annuities payable, this type of annuity
includes payments made in equal time intervals and in equal amounts, or amounts that are
increasing or decreasing according to some mathematical principle. (Trklja, 2008)

Annuities can be received annually, semianually, monthly, or in some other time frame. Interest
can also be converted in any time frame. Therefore, annuity receiving periods and interest
conversion periods may or may not be the same.

Annuities receivable can be in equal amouts or in varying amunts. If they are variable, they can
be increasing or decreasing following arithmetic progression or geometric progression. (Trklja,
2008)

4.1. Immediate annuities receivable

Invested value of immediate annuities receivable is formed one payout period before receiving
the first annuity. (Trklja, 2008)

.The formula for immediate annuities receivable is: K=R × IV np (Trklja, 2008)

11
4.2. Annuities due receivable

Invested value of annuities due receivable is formed in the moment of receiving the first annuity.

Figure 10: Timeline depicting annuities due receivable.

The formula for annuities due receivable is: K '=R × ( 1+ IV p ) (Trklja, 2008)
n −1

For the given timelines we will do same example.

1. How much should we invest if we want to receive 100KM yearly with p=7%
a) At the end of year
b) At the beginning of the year

a) R=100KM
P=7%
n=15
K=?

n
K=R × IV p
K=100× IV 15
7
K=100× 9.107914005
K= 910.7914005

b) R=100KM
p=7%
n=15
K'=?
K '=R × (1+ IV p )
n −1

K =100 × ( 1+ IV
' 14
7 )
K ' =100 × 9.745467985

12
 K'= 974.5467985

4.3. Annuities receivable more frequent than interest is compounded

This
type of
annuity
will
have
more payments than interest conversion moments. It can be due or immediate.

Figure 11: Timeline depicting immediate annuities receivable more frequent than interest is compounded. The

formula for immediate annuities receivable more frequent than interest is compounded is:

K=R m+ [ p ( m−1 )
200 ] n
× IV p (Trklja, 2008)

Figure 12: Timeline depicting annuities due receivable more frequent than interest is compounded.

The formula for annuities due receivable more frequent than interest is compounded is:

13
K '=R m+ [ 200 ]
p ( m+ 1 )
× IV np (Trklja, 2008)

For the given timeline how much should we invest if we want to receive 100KM semianually but
interest conversion is done annually and is 7%(d).

Immediate:

R=100KM

P= 7%

n=15

m=2

K=?

K=R m+ [ p ( m−1 )
200 ] n
× IV p

K=100 2+ [ 7 ( 2−1 )
200 ] 15
× IV 7

K=100 2+
[ 7
200 ]
×9.107914005

K=100× 2.035× 9.107914005

K=1,853.4605000175

Due:

R=100KM

P=7%

n=15

m=3

14
K'=?

K '=R m+ [ 200 ]
p ( m+ 1 )
× IV np

K ' =100 3+ [ 7 ( 3+1 )

200 ]× IV 15
7

' 28
K =100 × ⌈ 3+ ⌉ ×9.107914005
200

'
K =100 ×3.14 × 9.107914005

K ' =2,859.88499757

4.4. Annuities receivable less frequent than interest is compounded

This type of annuity will have less payments than interest conversion moments. It can be due or
immediate.

Figure 13: Timeline depicting immediate annuities receivable less frequent than interest is compounded.

15
The formula for immediate annuities receivable less frequent than interest is compounded is:

mn
IV p / n
K=R × m−1 (Trklja, 2008)
1+ III p / m

The formula for annuities due receivable less frequent than interest is compounded is:

IV mn
K ' =R × p /m
(Trklja, 2008)
IV mp /m
For the given timeline how much should we invest if we want to receive 100KM anually but
interest conversion is done semiannaully and is 15%(d).
Figure 14: Timeline depicting annuities due receivable less frequent than interest is compounded.
Immediate:
R=100KM
p=15%
n=15
m=2
K=?

mn
IV p / n
K=R × m−1
1+ III p / m
30
IV 1
K=100× 1
1+ III 7,5
25.807708221
K=100×
1+1.075000000
K=100× 12.4374497451
K=1,243.74497451
Due:

16
R=100KM
p=15%
n=15
m=3
K'=?
mn
' IV p /m
K =R × m
IV p /m
' IV 45
5
K =100 ×
IV 35
' 17.774069822
K =100 ×
2.723248029
'
K =650.4738529

4.5. Annuities receivable varying in accordance with arithmetic or geometric

progression
Just like annuities payable, annuities receivable can also have a varying cash flow as long as it is
in accordance with some mathematical principle.

The formulas for arithmetic annuities receivable are:

100 d
Immediate: K=R 1 × IV p ±
n
p
( IV p −n × II p )
n n

d ( 100+ p )
Due: K =R1 (1+ IV p ) ± × ( IV p −n × II p )
' n−1 n n−1
p

The formulas for geometric annuities receivable are:

n n n n
r −q q −r
Immediate: K=R 1 n or K=R 1 n
r ( r−q ) r ( q−r )
r ( r −q ) r ( q −r )
n n n n
' '
Due: K =R1 × n or : K =R1 × n
r ( r −q ) r ( q−r )

(Trklja, 2008)

17
5. CONCLUSION

Annuities are an incredibly important part of financial mathematics. However, they are also a
very broad topic, which is why this paper (even though it is not short or brief) only begins to
cover this very interesting topic. There is still a lot to be analyzed and learned about annuities.

Each different type of annuity brings its own characteristics and challenges. That is what makes
this topic so dynamic. It could be possible to write about annuities for many more pages, so we
hope that our knowledge of them will one day be ever more vast.

The examples of problems that we have solved in this paper are very basic. Problems involving
annuities can get a lot more complicated and twisted, but one must first crawl in order to learn to
walk.

As business students it is of crucial importance that we fully get acquainted with annuities and
try to understand them to the best of our abilities. Learning how to solve problems involving
annuities is sure to benefit our academic career. As they are a great way of investing and earning
money, understanding how annuities work could be relevant to our future.

18
 REFERENCES

1. CFI, 2022. Corporate Finance Institute. [Online]

Available at: https://corporatefinanceinstitute.com/resources/data-science/perpetuity/
[Accessed 23 November 2022].

2. Giuseppe Campolieti, R. N. M., 2014. Financial Mathematics. New York: Chapman and
Hall/CRC.

3. Kellison, S. G., 2009. The Theory of Interest. 3rd ed. s.l.:McGraw-Hill.

4. Olivier, J.-P., 2021. Fundamentals of Annuities. [Online]

Available at:
https://math.libretexts.org/Bookshelves/Applied_Mathematics/Business_Math_(Olivier)/
11%3A_Compound_Interest_Annuities/11.01%3A__Fundamentals_of_Annuities
[Accessed 22 November 2022].

5. Reuters, T., 2022. Annuity | Practical Law. [Online]

Available at: https://ca.practicallaw.thomsonreuters.com/1-107-6404?
transitionType=Default&contextData=%28sc.Default%29&firstPage=true
[Accessed 23 November 2022].

6. Trklja, B., 2008. Finansijska Matematika. 3rd ed. Sarajevo: Ekonomski fakultet u
Sarajevu Izdavačka Djelatnost.

7. Wai-Sum Chan, Y.-K. T., 2017. Financial Mathematics for Actuaries. 2nd ed. s.l.:World
Scientific.

19
 TABLE OF FIGURES

Figure 1: Timeline depicting annuities due.....................................................................................3

Figure 2: Timeline depicting annuities immediate..........................................................................3
Figure 3: Timeline depicting annuities due payable less frequent than interest is compounded.....5
Figure 4: Timeline depicting immediate annuities payable less frequent than interest is
compounded.....................................................................................................................................5
Figure 5: Timeline depicting annuities due payable more frequent than interest is compounded.. 7
Figure 6: Timeline depicting immediate annuities less frequent than interest is compounded.......7
Figure 7: Timeline depicting an arithmetic annuity........................................................................9
Figure 8: Timeline depicting a geometric annuity.........................................................................10
Figure 9: Timeline depicting immediate annuities receivable. R represents the receivable annuity,
while the blue dots represent the moments of interest conversion................................................11
Figure 10: Timeline depicting annuities due receivable................................................................12
Figure 11: Timeline depicting immediate annuities receivable more frequent than interest is
compounded...................................................................................................................................13
Figure 12: Timeline depicting annuities due receivable more frequent than interest is
compounded...................................................................................................................................13
Figure 13: Timeline depicting immediate annuities receivable less frequent than interest is
compounded...................................................................................................................................15
Figure 14: Timeline depicting annuities due receivable less frequent than interest is compounded.
.......................................................................................................................................................15

20