Financial Management

Fundamental of Annuities – Meaning and Types

What is an Annuity?

An annuity is a continuous stream of equal periodic payments from one party to another for a certain length of time in order to satisfy a financial commitment.

The dollar amount of the equal periodic payment in an annuity scenario is the annuity payment. The payments are continuous, equal, periodic, and take place over a predetermined length of time. If any of these four conditions are not met, the financial transaction does not fulfil the definition of a singular annuity and must be solved using alternative methods and formulas.

Four Types of Annuities

There are four different types of annuities depending on the combination of two fundamental characteristics: payment time and payment frequency.

Ordinary Simple Annuity

The following are characteristics of a standard simple annuity:

  • The payment and compounding frequencies are equal, and payments are made at the end of the payment periods.
  • The first payment is made one period after the start of the annuity.
  • The final payment is made on the same date that the annuity ends.

Ordinary General Annuity

Typical general annuity features are as follows:

  • The payment and compounding frequencies are unequal, and payments are made at the conclusion of the payment periods.
  • The first payment is made one period after the start of the annuity.
  • The final payment is made on the same date that the annuity ends.

Simple Annuity Due

The following characteristics define a simple annuity due:

  • The payment and compounding frequencies are equal, and payments are made at the beginning of payment periods.
  • The first payment is made on the same date as the annuity begins.
  • The last payment is made one payment interval prior to the conclusion of the annuity.

General Annuity Due

The following characteristics define a general annuity due:

  • The payment frequency is greater than the compounding frequency, and payments are made at the beginning of the payment intervals.
  • The first payment is made on the same date as the annuity begins.
  • The last payment is made one payment interval prior to the conclusion of the annuity.

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