Ordinary Annuity
Contents
Demystifying Ordinary Annuities: A Guide to Understanding Financial Terms
How Does an Ordinary Annuity Work?
An ordinary annuity involves a series of equal payments made at the end of consecutive periods over a fixed timeframe. These payments, typically monthly, quarterly, or annually, are different from the financial product known as an annuity. Examples include regular interest payments from bonds or quarterly dividends from stocks.
Understanding the Present Value of an Ordinary Annuity
The present value of an ordinary annuity depends on factors like the prevailing interest rate. Rising interest rates decrease the present value, while declining rates increase it. This is because the annuity's value is based on the return your money could earn elsewhere.
Present Value Calculation Example
To calculate the present value of an ordinary annuity, you use the formula: Present Value = PMT x ((1 - (1 + r) ^ -n ) / r). For instance, if an annuity pays $50,000 per year for five years at a 7% interest rate, the present value would be $205,010.
Comparing Ordinary Annuities and Annuities Due
An ordinary annuity pays at the end of each period, while an annuity due pays at the beginning. Annuities due are typically more valuable because money is received earlier. For example, if the same annuity were due instead, its present value would be $219,360.