MAMI OLOF

Lecture 4 117102
annuities

note please watch the lecture video

for Lesson that
4 Dr Uys uploaded
in the Lesson tab on Vala

Lecturer James Mbewa

Last time in MAMI Olof
Compound Interest Mt Formulae
FV PV I E PV Iti i E n mt
n
PV FV Iti INT FV PV
Compound Interest Timeline
a.MX
n periods
pf
Compound Interest examples
a
calculating FU PV INT inflation
Compound Interest Time Machine
The Equation of Value
examples multiple payments multiple debts
changing interest
rates
note this is probably the most important section in
the financial maths section

Sinking funds
examples combined with equation of value
Annuities
Consider a sum D is borrowed from a bank
of money
which charges compound interest at a rate n pa
The loan is repaid by regular payments with the same
frequency m as the interest is compounded The payments
are made at the end of each interest period
This scenario can be expressed on a timeline
fd

fi
n periods

D PMT PMT PMT

For convenience we choosefocal date at the end of the

the
term We know the future value of payments at the end of the
term using the sinking value formula

By the equation of value the future value FV

of all of the
payments brought forward to the f d should equal the future
value of the debt D brought forward to the f d
D d ti pmtftti.IT i E
 D pmt IIIa
Pmt

Annuity Formula D pmtfi C.it J

note that this is the same as the sinking fund formula
but with n instead of n and the signs in the numerator
swapped
also note that the annuity formula gives you the value
of a sum of payments D a the
beginning of the term
Sinking fund formula us Annuity Formula

FV PMT III D pmtfi c.IT

gives you the sum of payments gives you the sum of payments
FV at the end of the term D at the beginning of the term

usually used when you have usually used when you take
a series of payments into a out a loan of size D at the
and want beginning of the term and
know the total value in
pay it off with a series
In
to
me no m

if your focal use this formula if your

datenth
is formula
at the end of the focal date is at the
beginning of the payments

Quick reminder a loan isdebt you have with the bank

a
ie you owe the bank money
an investment savings can be thought of
as a debt the bank has with you
i e the bank owes you money
Example 3
You wish to establish a trust fund from which your niece
can withdraw $2,000 every 6 months for 15 years, at the
end of which time she will receive the remaining money in
the trust, which you would like to be $10,000. The trust will
be invested at 7% per year compounded every 6 months.
How large should the trust be?

i i
I 2000 2 00
sooth
10 000
for convenience we choose the focal date at the beginning
of the term because T is the unknown we want to find

The T is lent to the bank at the beginning of the

amount
term and the bank must repay this debt by repayments
of 2000 six monthly semi annually for 15 years
together with an additional final payment of 10 000
at the end of the term

The equation of value at the f d gives

T
use
It'll
the annuity formula
10 000 Iti is
n
I
15 2
because payments are
brought backwards to
the beginning of the term
s
2000 L 4I J t 10 000 Ito

40346.81
 Example 4
Jane has just started her new job with Big Conglomerate,
Inc., and is already looking forward to retirement. BCI
offers her as a pension plan an annuity account that is
guaranteed to earn 6% annual interest compounded
monthly. She plans to work for 40 years before retiring and
would then like to be able to draw an income of $7,000 per
month for 20 years. How much does she and BCI together
have to deposit per month into the account to accomplish
this?

We first need to find out the balance T in the account

at the beginning of her 20 year pension payout period
fd 12

T 7000 7000
41 years
120
7000
We choose the focal date at the beginning of the term

Because the focal date is at the beginning of the term

we use the annuity formula
cotta
J
1 i
T pMT n 20 12
4 20
700011 1
977 065.40

Now we can find out the deposits PMT needed to

accumulate to the balance T 977 065.40

Ftp
40 gears

PMT I
977 065.40
This is a standard sinking fund problem
 4ti
Ev pmT J i It
Y 40 12
n
977 065.210 pmt
PMT 49012
Example 5
Marc and Mira are buying a house and have taken out a
30-year, $90,000 mortgage at 8% interest per year. What
will their monthly payments be?

O
M i
130 years

I p
90000 PMT PMT PMT
This is a standard annuity problem
foot
pmtfl 1 fi
4 o
D 30
n 30 12

90000 Pmt
1
4.10
PMT
660.31