Chapter 5 -Tutorial Solutions -Additional FIA 3271 Introduction

to Finance

Chapter 5 (Tutorial)- Solutions

1. A dollar received today is worth more than a dollar received a year from now.

2. Simple interest is the interest earned only on the initial investment. Interest is not
earned on any accumulated interest.

3. Compound interest calculated on the initial principal, which also includes all the
accumulated interest from previous periods on a deposit or loan. In simpler terms, it's
interest on interest.

4.
Years 0 1 2 3 4
Cash flow –100 30 20 –10 50

5. The future value of an investment is the amount to which an investment will grow
based on the amount of years invested and interest rate it can earn.

The future value of an investment can be increased either by increasing the

number of years we let the investment compound or by compounding the
investment at a higher rate.

6. Present value is the value in today’s dollars of a sum of money to be received in

the future.

Present value factor is the value used as a multiplier to calculate an amount’s

present value. We use the table called Present Value Factor when the streams of
cash flow is one time and we use Present Value Annuity Factor when there is a
constant stream of cash flow every year.

7. An annuity is a series of equal dollar payments for a specified number of years.

Because annuities occur frequently in finance—for example, bond interest payments.
A compound annuity involves depositing or investing an equal sum of money at the
end of each year for a certain number of years and allowing it to grow.
8. An annuity due is an annuity in which the payments occur at the beginning of
each period. Annuities due are just ordinary annuities in which all of the annuity
payments have been shifted forward by one year.

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Chapter 5 -Tutorial Solutions -Additional FIA 3271 Introduction
to Finance

An annuity due typically has a higher present value (PV) compared to an ordinary
annuity, assuming all other factors remain constant. This is because in an annuity
due, payments are made at the beginning of each period, while in an ordinary
annuity, payments are made at the end of each period.

The future value of an annuity due is higher than the future value of an ordinary
annuity, assuming all other factors remain constant.

In an annuity due, payments are made at beginning of each period, allowing for more
time for each payment to earn interest. As a result, each payment has more time to
compound, leading to higher future value compared to an ordinary annuity.

Annuity Due (cash flow diagram)

Ordinary Annuity ( cash flow diagram)