Annuities theory

Question 1

What are annuities?

Answer 1

They are a series of payments made at regular intervals such as annually, quarterly, etc.

Question 2

What are level annuities?

Answer 2

They are strategies required for annuities with the same payment amount.

Question 3

What does s-angle-n represent?

Answer 3

It is the accumulated value of a level annuity-immediate with payments of 1$ for “n” periods valued on the last payment date.

Question 4

What does a-angle-n represent?

Answer 4

It is the present value of a level annuity-immediate with payments of 1$ for “n” periods valued one period before the first payment date.

Question 5

What is an annuity-immediate?

Answer 5

It is an annuity where the comparison date of the present value is one period before the first payment.

Question 6

What is an annuity-due?

Answer 6

It is an annuity where the comparison date of the present value is on the first payment date.

Question 7

What does s-double-dot-angle-n represent?

Answer 7

It represents the accumulated value of a level annuity with payments of 1$ for “n” periods valued one period after the last payment date.

Question 8

What does a-double-dot-angle-n represent?

Answer 8

It is the present value of a level annuity with payments of 1$ for “n” periods valued on the first payment date.

Question 9

What is a deferred annuity?

Answer 9

It’s an annuity that starts after a deferred period

Question 10

What is the concept of a perpetuity?

Answer 10

It is an annuity with payments continuing forever.

Question 11

What is a perpetuity-immediate?

Answer 11

It is a perpetuity with payments starting one period after the comparison date.

Question 12

What is a perpetuity-due?

Answer 12

It is a perpetuity with payments starting at the comparison date.

Question 13

What is a balloon payment?

Answer 13

It is when the last payment is larger than the regular payment.

Question 14

What is a drop payment?

Answer 14

It is the additional amount made 1 period after the last regular payment.

Question 15

What is the portfolio rate method?

Answer 15

All deposits earn the same interest during the same time period.

Question 16

What are the components of the portfolio rate method?

Answer 16

• This is similar to making multiple deposits into a savings account.
• The savings accounts function like a single portfolio.
• When the interest rate on the savings account changes, the interest rate for the entire fund (or portfolio) changes.

Question 17

What is the yield curve method?

Answer 17

It is when interest is based on when money was deposited (when payment occurs).

Question 18

What are the components of the yield curve method?

Answer 18

• Consider each deposit as a separate fund where the interest rate for a new deposit earns a different interest rate.
• In other words, at a given time, different funds may be credited with different interest rates.

Question 19

What happens in a non-level annuity with arithmetic progression if Q<0?

Answer 19

It means that the payment is decreasing over years.

Question 20

What is happening if in a non-level annuity, P=Q?

Answer 20

We have an increasing annuity where the first payment is equal to the payment increase.

Question 21

What are “off” annuities?

Answer 21

They are annuities with payments occurring more or less frequently than interest convert.

Question 22

What is the j-effective method?

Answer 22

It consists of converting an interest rate to an equivalent effective rate “j” that matches the payment frequency.

Question 23

What are continuous varying annuities?

Answer 23

It is when payments are made continuously and the rate of payment at any exact moment “t” is “t”

Question 24

What are block payments?

Answer 24

It is when payments that stay level for a period of years, then change to another level for another period of years, etc.

Question 25

What is the first method to evaluate block payments?

Answer 25

1) It is to start with payment furthest from the comparison date.
2) After that, we make adjustments when moving toward the comparison table.

Question 26

What is a DCF analysis?

Answer 26

It is when an investor has to choose which investment is adequate for his money.

Question 27

What are the 2 factors to take into account while making a DCF analysis?

Answer 27

1) The net present value (NPV)
2) The internal rate of return (IRR)

Question 28

What is the net present value?

Answer 28

It is the sum of the present values of all cash flows over “n” years.

Question 29

Can an NPV be inferior to 0?

Answer 29

No, because in that case it will be rejected.

Question 30

What is the opportunity cost of capital?

Answer 30

It is the rate of return on an equally-risky asset an investor could have earned if he or she had not invested in the project.

Question 31

What is the internal rate of return (IRR) or yield rate?

Answer 31

It is the interest rate that produces a zero net present value. It is causing a project to break even.