ActSc 231

Oct 19 and Oct 21 2015

3.3 Annuities due
1. A couple wants to accumulate $10,000 by Dec 31, 2015. They make 10 annual deposits starting Jan 1, 2006. If the annual effective rate of interest is 2%, what annual deposits are needed?
Sol: The first payment is on Jan 1 (time 0), 2006 and the last is on Jan 1, 2015 (time 9). There
are 10 payments and Dec 12, 2015 is time 10.
10000 = R
s10|2% R =

10000
1.0210 1
11.021

= 895.36

Note that d = 1 (1 + i)1 .

2. Starting on his 45th birthday, a man deposits $10,000 a year in an investment account that
pays interest at i=3%. He makes his last deposit on his 64th birthday. On his 65th birthday he transfers his total savings to a special retirement fund that pays i=4.5%. From this fund he will receive
level payments of $X at the beginning of each year for 15 years (first payment on his 65th birthday).
Determine X.
Sol: There are 20 deposits in total. The AV at age 65 is
10000
s20|3% = 10000

1.0320 1
= 276764.86.
1 1.031

The PV of all retirement payments equals this AV. There are 15 payments
276764.86 = X
a15|4.5% X =

276764.86
11.04515
11.0451

= 24660.89.

3. Kathryn deposits $100 into an account at the beginning of each 4-year period for 40 years. The
account credits interest at an annual effective interest rate of i. The accumulated amount in the
account at the end of 40 years is $X, which is 5 times the accumulated amount in the account at the
end of 20 years. Calculate X.
Sol: The effective interest rate for 4 years is j = (1 + i)4 1. The AV at the end of 20 years is
100
s5|j , at the end of 40 years is 100
s10|j , hence we have
s10|j = 5
s5|j
(1 + j)10 1
(1 + j)5 1
=5
1
1 (1 + j)
1 (1 + j)1
Put y = (1 + j)5 , we have y 2 5y + 4 = 0 y = 1 or 4. If y = 1 then j = i = 1. Check this is not a
solution to our problem. Therefore y = 4 (1 + j)5 = 4 (1 + j)1 = 0.757858, and
X = 100
s10|j = 100

(1 + j)10 1
= 6194.72.
1 (1 + j)1

4. Given an+1|i an|i = 0.177208656 and a

n+1|i a
n|i = 0.185248436. Find n.
Sol:
an+1|i an|i = v n+1 (n + 1) ln v = ln 0.177208656
a
n+1|i a
n|i = v n n ln v = ln 0.185248436
1

Divide the first equation by the second, we have

n+1
n

=1+

1
n

ln 0.177208656
ln 0.185248436

n = 38.

3.4 Perpetuities
1. Cheryl receives a 60-year annuity-due. The annual payments are $3000 during the first 20 years
and $6000 during the next 40 years. Dan receives a perpetuity-immediate with annual payments.
The odd numbered payments are P and the even payments are 2P . The PV of Cheryls and Dans
payments are equal using i(1) = 5%. Find P .
Sol: The PV of Cheryls annuity-due is
a40|5% (1 + 5%)20 = 6000
a60|5% 3000
a20|5% = 79998.56.
3000
a20|5% + 6000
The PV of Dans perpetuity-immediate is
P a|5% + P a|10.25% =

P
P
+
.
0.05 0.1025

Equate the two PVs, we have

P =

79998.56
= 2688.48.
1
+ 0.1025

1
0.05

2. Find the PV of a perpetuity with annual payments of $500. The first payment is in 7 weeks and
i(1) = 6%.
Sol: The value of this perpetuity 52 weeks before the first payment is 500/0.06. Move it forward
45
500
45 weeks, the PV is 0.06
(1.06) 52 = 8764.32.
3. Find the PV of a perpetuity with semi-annual payments of $300. The first payment is in 10
months and i(12) = 6%.
Sol: The monthly effective rate is 0.5% and the semi-annually effective rate is 1.0056 1 = 3.03775%.
The value of the perpetuity 6 months before the first payment is 300/0.0303775. Bring back 4 more
300
month, the PV is 0.0303775
(1.005)4 = 9680.66.
4. A perpetuity-immediate pays $100 per year. Immediately after the fifth payment, the perpetuity is exchanged for a 25-year annuity-immediate that will pay $X at the end of each year. The
annual effective rate of interest is 8%. Calculate X.
Sol: The value of the perpetuity right after the fifth payment is 100/0.08, which should be equal
to Xa25|8% . Therefore,
100
= Xa25|8% X = 117.10.
0.08

3.5 Deferred annuities and values on any date

1. Determine the value on Jan 1, 2011 of quarterly payments of $100 over 10 years, if the first
payment is on Jan 1, 2013 and interest is 7% compounded quarterly.
Sol: Let Jan 1, 2011 be time 0 and each period corresponds to one quarter. The first payment
is on Jan 1, 2013 (t = 8) and the last payment is on Oct 1, 2022 (t = 47). The value of this annuity
on Oct 1, 2012 (t = 7) is 100a40|1.75% . Note there are 40 payments in total and the quarterly effective
2

rate is 7%/4 = 1.75%. Then the value of the annuity at t = 0 is 100a40|1.75% (1.075)7 = 2532.43.
2. On her 18th birthday, Latisha receives an annuity that is to pay $5000 on her 25th through
39th birthdays.
(a) Calculate the value of the annuity on her 50th birthday using an annual effective interest rate of
5%.
(b) Calculate the value of the annuity on her 30th birthday using an annual effective interest rate of 5%.
Sol:
(a)
1. Subtracting two annuities immediate: 5000(s26|5% s11|5% ) = 184533.33.
2. Subtracting two annuities due: 5000(
s25|5% s10|5% ) = 184533.33.
3. Accumulate one annuity immediate: 5000s15|5% (1.05)11 = 184533.33.
4. Accumulate one annuity due: 5000
s15|5% (1.05)10 = 184533.33.
15

5. The first principle: 5000[(1+i)25 +(1+i)24 + +(1+i)11 ] = 5000(1+i)11 1(1+i)

1(1+i) = 184533.33.
(b)
The value of the payments have already made is 5000s6|5% , the value of the payments to be made is
5000a9|5% . Their sum is 69548.67. Using annuities due formulas, we equivalently have 5000
s5|5% 5000
a10|5% =
69548.67.
3. Sydney wins a prize. She has a choice of receiving a payment of $160,000 immediately or of
receiving a deferred perpetuity with $10,000 annual payments, the first payment occurring in exactly
four years. Which has a greater present value if the calculation is based on an annual effective interest
rate of 5%? How about 6%? What real life considerations should enter into Sydneys choice besides
maximizing her present value?
Sol:
10000
(1 + 0.05)3 = 172767.52 > 160000
0.05
10000
(1 + 0.06)3 = 139936.55 < 160000
0.06
The possibility of death during the deferment period.

3.7 Nonlevel annuities

1. Deposits are $100 per month for 3 years, nothing for 2 years, and then $200 per month for 3
years. Interest rates start at i(12) = 8% and fall to i(12) = 6% on the date of the first $200 deposit.
Determine the AV at the time of the final $200 deposit.
Sol: Let the length of one period be a month and assume the first $100 is deposited at t = 1.
Then the last $100 is deposited at t = 36, the first $200 is deposited at t = 61 and the last $200 at
t = 96. The monthly effective rate before t = 61 is 0.66% and is 0.5% afterwards. The value of the 36
$100 payments at t = 96 is 100s36|0.66% (1 + 0.66%)25 (1 + 0.5%)35 . The value of the 36 $200 payments
at t = 96 is 200s36|0.5% . Therefore the total value is 13566.11. Please refer to lecture notes for the
cash flow.
2. Find the PV of an annuity which pays $75 at the end of each month during the first year, $50 at
3

the end of each month in the second year and $25 at the end of each month during the third year.
Assume an annual effective interest rate of 5%.
Sol: The monthly effective rate is j = 0.4074124%. The PV of the first years payments is 75a12|j ,
of the second years payments is 50a12|j (1 + j)12 , of the third years payments is 25a12|j (1 + j)24 .
The total PV is 1698.23.
The second way to group the payments is: 1) the monthly payment of $25 lasting 1 year, plus 2) the
monthly payment of $25 lasting 2 years, plus 3) the monthly payment of $25 lasting 3 years. Therefore
the total PV is 25(a12|j + a24|j + a36|j ) = 1698.23.
3. To accumulate $217,593.30 at the end of 5n months, deposits of $100 are made at the end of each
of the first 2n months and $300 at the end of the next 3n months. Given that (1+i)n = 92.372, find n.
Sol: Since i is the annual effective rate, we have (1 + j)12n = 92.372 if j denotes the monthly effective rate. This gives (1 + j)5n = 6.591361706 and (1 + j)3n = 3.100166983.
100s5n|j + 200s3n|j = 100

(1 + j)5n 1
(1 + j)3n 1
979.1695673
+ 200
=
= 217, 593.30.
j
j
j

Therefore j = 0.45% and n = 84.

End-of-chapter problems (no solution will be provided)

3.3: 4, 5, 6, 10
3.4: 1, 2, 6
3.5: 3, 4
3.7: 2, 4, 6, 8