Question

An annuity is a series of equal-sized cash flows occurring over equal intervals of time. An ordinary annuity exists when the cash flows occur at the end of each period. An annuity due exists when the cash flows occur at the beginning of each period.

Which of the following statements about annuities are true?

1) The first cash flow of an annuity due is made on the first day of the agreement.

2) The first cash flow of an ordinary annuity is made on the first day of the agreement.

3) The last cash flow of an annuity due is made on the day covered by the agreement.

4) The last cash flow of an ordinary annuity is made on the last day covered by the agreement.

Answer 1

(1)  The first cash flow of an annuity due is made on the first day of the agreement : TRUE

Annuity-due: Payments are made at the beginning of the period. For example, if a period is one month, payments are made on the first of each month. A common example of an annuity due payment is rent, as landlords often require payment upon the start the month.

(2) The first cash flow of an ordinary annuity is made on the first day of the agreement. : FALSE

Ordinary Annuity: Payments are made at the end of the period. If a period is one month, this means that payments are made on the 28th/30th/31st of each month. Mortgage payments are usually ordinary annuities.

(3) The last cash flow of an annuity due is made on the day covered by the agreement. : FALSE

Annuity-due: The last cash flow occurs one period before the termination/ completion of agreement.

(4)  The last cash flow of an ordinary annuity is made on the last day covered by the agreement : TRUE

Ordinary Annuity: For an ordinary annuity, the final cash flow takes place on the last day covered by the agreement.