Question 1

What is the difference between an ordinary annuity and an annuity due?

Accepted Answer

An ordinary annuity pays at the end of each period, while an annuity due pays at the beginning. Because each payment in an annuity due earns interest for one extra period, an annuity due is always worth more than an ordinary annuity with the same terms.

Question 2

What is the future value of an annuity formula?

Accepted Answer

FV = PMT × [((1 + i)^n - 1) / i], where PMT is the periodic payment, i is the interest rate per period, and n is the number of periods. For an annuity due multiply the result by (1 + i).

Question 3

How is the present value of an annuity calculated?

Accepted Answer

PV = PMT × [(1 - (1 + i)^-n) / i]. It discounts each future payment back to today. The further out a payment, the less it is worth in present-day dollars.

Question 4

How do I convert an annual rate to a periodic rate?

Accepted Answer

Divide the nominal annual rate by the number of periods per year (12 for monthly, 4 for quarterly). For example, 6% annual / 12 = 0.5% per month. Likewise multiply years by the periods per year to get the total number of periods n.