What Are Ordinary Annuities, and How Do They Work?

Definition

An ordinary annuity is a financial product that involves a series of equal payments made at the end of consecutive periods over a specified duration.

What Is an Ordinary Annuity?

An ordinary annuity is a series of equal payments made at the end of consecutive periods over a fixed length of☂ time. Ordinary annuities may be paid monthl🦩y, quarterly, semi-annually, or annually.

The opposite of an ordinary annuity is an annuity due, in which payments are made at the beginning of each period. A .rent payment is an annuity due. A mortgage payment is an ordinary annuity♏.

N💎either an ordinary annuity nor an annuity due refers to the financiaꦫl product known as an annuity, though they are related.

Key Takeaways

An ordinary annuity is a series of regular payments made at the end of each period, such as a month or a quarter.
In an annuity due, payments are made at the beginning of each period.
Stock dividends and bond dividends are examples of ordinary annuities. A monthly rent payment is an example of an annuity due.

Ordinary Annuity: A series of equal payments made at the end of each period over a fixed amount of time. — Investopedia / Zoe Hansen

How an Ordinary Annuity Works

An exam꧒ple of an ordinary annuity is the interest payment on a bond. Theꦑse are generally made semiannually. Regular quarterly dividends from a stock that has maintained a stable payout level for years are another example.

The 澳洲幸运5官方开奖结果体彩网:present value of an ordinary annuity is largely dependent on th🍌e prevailing interest rate.

Because of the 澳洲幸运5官方开奖结果体彩网:time value of money, rising interest rates reduce the present value of an ordinary annuity, while declining interest rates increase its present value. This is because the value of an annuity is based 𝔍on the return your money could earn elsewhere. If you can get a higher interest rate somewhere else, the value of t꧙h♔e annuity goes down.

Present Value of an Ordinary Annuity Example

💛The present value formula for an ordinary annuity takes into account three variables. They are:

PMT = the period cash payment
r = the interest rate per period
n = the total number of periods

Given these variables, the ༒present value of an ordinarꩵy annuity is:

Present Value = PMT x ((1 - (1 + r) ^ -n ) / r)

For example, if an ordinary annuity pays $50,000 per year for five years and the interest rate is 7%♐, the p🥂resent value would be:

Present Value = $50,000 x ((1 - (1 + 0.07) ^ -5) / 0.07) = $205,010

Important

An ordinary annuity ꦆwill have a lower present value than an annuity due, all else being equaꦫl.

Present Value of an Annuity Due Example

An investor with an ordinary annuity receives the payment at the end of the agree🌌d tim💟e period.

An alternative is an annuity due, in which the investor receives the payment at the beginning of the period. A common example is rent. The r🅺enter typically pays the la🐷ndlord in advance for the month ahead.

This difference in 🧔payment timing affects the value of the annuity. The formula for an annuity due is as follows:

Present Value of Annuity Due = PMT + PMT x ((1 - (1 + r) ^ -(n-1) / r)

If the annuity in the ⛎above example was instead an annuity due, its present value would be calculated as:

Present Value of Annuity Due = $50,000 + $50,000 x ((1 - (1 + 0.07) ^ -(5-1) / 0.07) = $219,360.

All else being equal, an annuity due 澳洲幸运5官方开奖结果体彩网:is worth more than an ordinary annuity because the money is received earliꦫer.

Is an Ordinary Annuity Better Than an Annuity Due?

Generally, an annuity due is better for the party that is paying and not as good for the recipient. The recipient is paying up front for the period ahead. With an ordinary annuity, the payment is made at the end of the previous period. Money has a 澳洲幸运5官方开奖结果体彩网:time value. The so🐷oner a person gets paid, the more the money is worth.

What Is an Annuity?

The word annuity commonly refers to an in𒊎surance product purchased by an individual. In return for a lump-sum payment or a series of payments to the financial institution, the individual receives a stea💖dy stream of regular payments. The annuity is most often used as a source of retirement income.

What Are the Most Common Types of Ordinary Annuities?

The most common types of ordinary annuities are stock and bond dividends. These are paid at the end of each period of the agreement rather than at the beginning of the period. In the case of stock dividends, this is because the dividends are based on the company's profits for the immediate preceding period.

The Bottom Line

Ordinary annuity is a bus🤡iness term that describes any regular payment that is made at the end of a relevant cycle rather than at its start. If you have a dividend-paying stock or a bond, you have an ordinary♔ annuity.

澳洲幸运5官方开奖结果体彩网