Question

Describe an ordinary annuity and an annuity due. Be clear on how they are the same and how they differ.

Answer 1

ORDINARY ANNUITY : It is a seris of equal amount of payments to be paid at end of each consecutive interval of time like weekly, monthly,quaterly,semi-annually,annually or at specific period of time. Present value of ordinary annuity depends upon current market rate. Formula to calculate ordinary annuity is :

PV= PMT x ((1 – (1 + r)^ – n) / r)

– PMT= the periodic payment

– r= the interest rate per period

– n= the total number of periods

ANNUITY DUE : Payments which are due immediately at the beginning of each period like rent. Person receiving annuity due considered that amount as an assests while person paying has a debt liability. formula to calculate annuity due :

• Present Value of Annuity Due = PMT + PMT x ((1 - (1 + r) ^ -(n-1) / r)

DIFERENCE BETWEEN ORDINARY ANNUITY AND  ANNUITY DUE :

. Cash flow in ordinary annuity is related to the period preceding its date or say at end of each period while cash flow in annuity due one period earlier than ordinary annuity or say at beginning of each period.

. oridnary annuity has lower present value than annuity due.

. Annuity due is worth more than ordinary due as money is received earlier than other.

. ordinary annuity is best suitable for person making payment whereas annuity due is suitable for persons collecting the payment.