MATHEMATICS

OF INVESTMENT
CBMEC 1

MIDTERM
ANNUITIES
 A strategy for saving a little bit of money in the present and
having a big payoff in the future is called an annuity.
 An annuity is an account in which equal regular payments are
made.
 There are two basic questions with annuities:
 Determine how much money will accumulate over time given that equal
payments are made.
 Determine what periodic payments will be necessary to obtain a specific
amount in a given time period.
1. Annuity certain
 The term of the annuity has been stipulated and agreed
upon between the policy holder and the creditor
 Example: Educational Plan
2. Contingent annuity
 The term depends on some certain event/s
 Example: Insurance Plan, Life Insurance Plan
Ordinary annuity
Payments and deposits are made at the end of each
payment interval
Annuity due
Deposits or payments are made at the beginning of
each payment interval
 How much money will you accumulate by the end of year
10 if you deposit ₱3,000 each for the next ten years in a
savings account that earns 5% per year?
 10

 The time line: i=5%

Time 0 1 2… 10

Cashflow: 3000 3000 … 3000

FV=[?]
 We want to know the future value of the 10 cash flows.
 We can compute the future value of each cash flow and sum them
together:
3000(1.05)9 + 3000(1.05)8 + … + 3000 = 37,733.68
 11

Interest rate 5%
Time 1 2 3 4 5 6 7 8 9 10
Cashflow 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00 3,000.00
Value in year 10 =3000*(1+.05)^(10-1) =3000*(1.05)^(10-8)
Value in year 10 4,653.98 4,432.37 4,221.30 4,020.29 3,828.84 3,646.52 3,472.88 3,307.50 3,150.00 3,000.00
Total 37,733.68

 The earlier cash flows have higher future values because they have
more years to earn interest.
 Year 1 cash flow can earn 9 years of interest.
 Year 10 cash flow does not earn any interest.
 12

 Since the annuity cash flow has a strong pattern, we can also
compute the future value of the annuity using a simple formula:

 FVn = FV of annuity at the end of nth period.

 PMT = annuity payment deposited or received at the end of
each period.
 i = interest rate per period
 n = number of periods for which annuity will last.
 13

 ₱3,000 for 10 years at 5% rate. Use the formula

1.05 10 −1
𝑭𝑽𝟏𝟎 = ₱3000
.05
(1.62889)−1
= ₱3,000
.05
.62889
= ₱3,000
.05
= ₱3,000 12.57789
= ₱37,733.68
 The treasurer of ABC Company invested the ₱8,000 of the
firm’s funds in a long-term investment vehicle for five years. He
expects that the company will earn 7% interest compounded
monthly. How much is the total value of their investment at the
end of the five-year period?
𝑖 = 𝑟/𝑚
𝑛 =𝑡×𝑚
Where:
r = interest rate
m = number of compounding periods
t = time
 ₱8,000 for 5 years at 7% rate, compounded monthly
.07 (5)(12)
1+ −1
𝑭𝑽𝟓 = ₱8000 12
.07
12
1.005833 60 −1
= ₱8,000 𝑖 = 𝑟/𝑚
.005833
1.4176253 −1 𝑛 =𝑡×𝑚
=₱8,000 Where:
.005833 r = interest rate
=₱8,000 71.59290 m = number of compounding periods
t = time
=₱572,743.21
1. Amount, ₱24,000; compounded monthly; 3%; 8 years
2. Amount, ₱54,000; compounded annually; 2.4%; 10 years
3. Amount, ₱48,000; compounded annually; 9%; 4 years
4. Amount, ₱42,000; compounded annually; 10%; 10 years
5. Amount, ₱72,000; compounded semi-annually; 9.5%; 8
years
6. Amount, ₱60,000; compounded quarterly; 7.5%; 12 years
WORKSHOP 2.1: Find the value of each ordinary
annuity at the end of the indicated time period.

 Amount, ₱2,000; monthly; 3%; 8 years

 Amount, ₱4,500; monthly; 2.4%; 10 years
 Amount, ₱4,000; monthly; 9%; 4 years
 Amount, ₱3,500; monthly; 10%; 10 years
 Amount, ₱6,000; monthly; 9.5%; 8 years
 Amount, ₱5,000; monthly; 7.5%; 12 years
 Amount, ₱2,500; quarterly; 8%; 5 years
 Amount, ₱750; quarterly; 9%; 3 years
 Amount, ₱2,800; quarterly; 3.6%; 6 years
 20

Instead of figuring out how much money

you will accumulate (i.e. FV), you may like
to know how much you need to save each
period (i.e. PMT) in order to accumulate a
certain amount at the end of n years.
 21

Formula to determine the value of PMT

PMT=FVn/[((1+i)n-1)/i]

𝑭𝑽𝒏
𝑷𝑴𝑻 =
𝒏
𝟏+𝒊 −𝟏
𝒊
 How much must you 𝑷𝑴𝑻 =
₱1,000,000
1+.065 10 −1
deposit every year in a
.065
savings account earning
₱1,000,000
6.5% interest in order to = .087713
accumulate ₱1,000,000 .065
at the end of 10 years?
₱1,000,000
=
13.494422

=₱74,104.69
 How much must you 𝑷𝑴𝑻 =
₱2,500,000
.0525 (15)(2)
deposit in a savings 1+ 2 −1
account earning 5.25% .0525
2
interest in order to
₱2,500,000
accumulate ₱2,500,000 at = 1.175680
the end of 15 years 0.02625
compounded semi-
₱2,500,000
annually? =
44.78782

=₱55,818.75
 24

1. Suppose you would like to have ₱300,000 saved for 6 years for your down payment on a
new house. If you are going to make equal annual end-of-year payments to an investment
account that pays 7%, how much is the annuity payment each year?
2. How much must you deposit in a savings account earning 8% interest in order to
accumulate ₱2,000,000 at the end of 10 years?
3. If you can earn 12% on your investments, and you would like to accumulate ₱150,000 for
your child’s education at the end of 18 years, how much must you invest annually to reach
your goal?
4. How much must be deposited at end of the year in an account that credits 1.25%
compounded semi-annually in order to accumulate ₱600,000 at the end of 5 years?
 The present value of an ordinary annuity
measures the value today of a stream of cash
flows occurring in the future.

By the same logic, receiving ₱5,000 today is worth more than getting ₱1,000 per year for five
years. The lump sum invested today is worth more at the end of the five years than the
incremental investments of ₱1,000 each, even if invested at the exact same interest rate.
 26

1
1−
FORMULA: (1 + 𝑖)𝑛
𝑃𝑉 = 𝑃𝑀𝑇
𝑖
PV = the present value of an annuity stream
PMT = the amount of each annuity payment
i = the interest rate (also known as the discount rate)
n = the number of periods in which payments will be made
 27

1
1−
(1 + .05)30
Example 1: What is the value today 𝑃𝑉 = 3000
0.05
or lump sum equivalent of receiving 1
1−
₱3,000 every year for the next 30 𝑃𝑉 = 3000 4.32194237515066
0.05
years if the interest rate is 5%? 1 − 0.231377448655858
𝑃𝑉 = 3000
Given: 0.05
0.768622551344142
PMT= ₱3,000 𝑃𝑉 = 3000
0.05
n= 30 years 𝑃𝑉 = 3000 15.37245103
i=5% or 0.05
𝑷𝑽 = 46117.35
 28

1
1−
(1 + .03)20
Example 2: Find the present value of 𝑃𝑉 = 24,000
0.03
an annuity with periodic payments of 1
1−
₱24,000, semi-annually, for a period of 𝑃𝑉 = 24,000 1.806111
0.03
10 years at an annual interest rate of 0.446324
6%, compounded semi-annually. 𝑃𝑉 = 24,000
0.03
Given: 𝑃𝑉 = 24,000 14.877475

PMT= ₱24,000
𝑷𝑽 = 357,059.40
n= 10 years ×2 =20
i=6%÷2 = 0.03
 29

Example 3: Assume an individual has the opportunity to

receive an annuity that pays ₱50,000 per year for the next
25 years with a 6 percent discount rate or a ₱650,000 lump-
sum payment, determine the more rational option.
Given:
PMT= ₱50,000
n= 25 years
i=6%
 31

1. Find the present value of an ordinary annuity with cash flows of ₱6,000 paid
monthly for 4 years at the interest rate of 4.40% per year, provided the
interest is compounded monthly.
2. Determine the present value of an annuity of ₱3,000 payable every quarter for
three years. The money is worth 6% compounded quarterly.
3. Find the present value of an annuity of ₱2,500 payable every end of the month
for six years. The money is worth 5.25% compounded monthly.
4. Assume an individual has the opportunity to receive an annuity that pays
₱50,000 per year for the next 20 years with a 3% percent discount rate or a
₱700,000 lump-sum payment, determine the better option.
 13-
33

 “Due” means that the payments are made at the

beginning of the payment interval.

 “Simple” means that the payment interval and interest

conversion interval are the same.
 13-
34

• Payments are made at the beginning of each payment

interval.

• You can identify an annuity due by such phrases as:

• “payable in advance”
• “payments (or deposits) made at the beginning
• of each (or every)…”
• “first payment is due on the date of sale”
 1+𝑖 𝑛 −1
𝑭𝑽𝒏(𝒅𝒖𝒆) = 𝑃𝑀𝑇 (1+i)
𝑖
Future Value Future value of
of simple annuity
═
ordinary annuity
× (1+i)
due
PMT is found the same way as
we did for Simple Annuities. Just
remember to include the (1+i) in
Where: your calculations.
FV = The future value of the annuity stream to be paid in the future 𝑭𝑽𝒏
𝑷𝑴𝑻 =
PMT = The amount of each annuity payment 𝒏
i = The interest rate 𝟏 + 𝒊 − 𝟏 (𝟏 + 𝒊)
n = The number of periods over which payments are to be made 𝒊
10,000 10,000 10,000 10,000 FV

1+𝑖 𝑛 −1
𝑭𝑽𝒏(𝒅𝒖𝒆) = 𝑃𝑀𝑇 (1+i)
𝑖
 How much money that you should invest at
3% for 5 years to have 200,000 at the
beginning of each period?
𝑭𝑽𝒏
𝑷𝑴𝑻 =
𝒏
𝟏 + 𝒊 − 𝟏 (𝟏 + 𝒊)
𝒊
Example: Annuity Due versus Ordinary Annuity
 Let’s say that you are saving up for retirement and decide to
deposit ₱24,000 each year for the next 20 years into an account
which pays a rate of interest of 8% compounded semi-annually.
By how much will your accumulated investment vary if you make
each of the 20 deposits at the beginning of the year, starting
right away, rather than at the end of each of the next twenty
years?
 1
1−
(1+𝑖)𝑛
𝑷𝑽𝑫𝒖𝒆 =𝑃𝑀𝑇 (1+i)
𝑖

PV = the present value of an annuity stream

PMT = the amount of each annuity payment
i = the interest rate (also known as the discount rate)
n = the number of periods in which payments will be made
 1
1−(1+𝑖)𝑛
𝑷𝑽𝑫𝒖𝒆 =𝑃𝑀𝑇 (1+i)
𝑖

 Payments of ₱42,500 are made at the beginning of each

quarter for 10 years. If money is worth 6% compounded
quarterly, find the present value of the total payments.
1
1−
(1+.015)40
𝑷𝑽𝑫𝒖𝒆 =42,500 (1+ 0.015)
0.015
1
1−
𝑷𝑽𝑫𝒖𝒆 =42,500 1.814018409
(1.015)
0.015
1−.5512623211
𝑷𝑽𝑫𝒖𝒆 =42,500 (1.015)
0.015
.448737679
𝑷𝑽𝑫𝒖𝒆 =42,500 (1.015)
0.015
 Number
Compounding
Annuity payment Interest of period
Period/s
(time)
10,000 every year 5% Annually 5 years
1 1
1−(1+𝑖)𝑛 1−(1+𝑖)𝑛
𝑷𝑽𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 =𝑃𝑀𝑇 𝑷𝑽𝑫𝒖𝒆 =𝑃𝑀𝑇 (1+i)
𝑖 𝑖 1
1−
(1+.05)5
1−
1
(1+.05)5
𝑷𝑽𝑫𝒖𝒆 =10,000 (1.05)
0.05
𝑷𝑽𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 =10,000 0.26473833
0.05
0.26473833 𝑷𝑽𝑫𝒖𝒆 =10,000 (1.05)
𝑷𝑽𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 =10,000 0.05
0.05
𝑷𝑽𝑫𝒖𝒆 =10,000 4.329476671 (1.05)
𝑷𝑽𝑶𝒓𝒅𝒊𝒏𝒂𝒓𝒚 =10,000 4.329476671
Formula Adjustment
PV annuity due = PV ordinary annuity x (1+i)
FV annuity due = FV ordinary annuity x (1+i)
PV annuity due > PV ordinary annuity
FV annuity due > FV ordinary annuity
Annuity payment at the Number
Compounding
beginning of the Interest of period 𝑷𝑽𝒅𝒖𝒆
Periods
payment interval (time)
45,000 every year 6.25% Annually 15 years
6,500 every quarter 5% Quarterly 20 years
3,700 every month 3.50% Monthly 25 years
25,000 every six 6% Semi-annually 30 years
months