Week 4 Flashcards
(27 cards)
Annuities
Payments of equal amounts at regular intervals over a finite number of periods (fixed time).
When valuing annuities, do you discount/compound each cash flow individually?
No, each cash flow is the same and is equally spaced over time so a single formula can be applied for ease of understanding and calculation.
Ordinary annuities
Annuities that are structured so that cash payments are paid or received at the end of each period (e.g. end of first month after you have paid money).
The most common form of annuities.
What 2 names are ordinary annuities AKA?
‘Annuity Arrears’ or a ‘Deferred Annuity.’
If nothing is said about the cash flows in a question then assume …
An ordinary annuity.
In ordinary annuities, the 1st cash flow occurs …
1 period after the start of the annuity.
Annuity due
Exactly the same as ordinary annuities, but the equal payments are paid or received at the START of each period.
Annuity is AKA
Annuity in advance
In annuity due, the first cash flow is due?
At the start of the annuity.
Example of an annuity due?
Rental lease.
How is the PV of annuity due different to that of ordinary annuities?
PV of ordinary annuities is the time period before the 1st payment, PV of annuity due is for the first time period of the 1st payment - exact same time.
How does annuity due formula differ from ordinary annuity formula?
Annuity due has (1 + i) at the end.
Deferred annuities
Annuities that do not start in Y0 (now) but in the future.
Deferred annuities are a common method used to …
Compare making buying or selling decisions of assets/liabilities today vs sometime in the future.
Growth annuities
Where the cash flow increases each period at a constant growth rate overtime.
Example of growth annuities
Superannuation.
Why do we do ‘n - 1’ in our discounting?
Because we don’t discount our first payment.
Can you do growth annuity calculations on a calculator?
No - because there is no way to put ‘g’ growth in calculator.
Perpetuity
An annuity where the cash flow continues for an indefinite period.
As with ordinary annuities, the ordinary perpetuity formula …
Establishes PV one period before the first cash flow.
When does the perpetuity due formula establish PV?
It establishes PV at the same period as the first cash flow.
Can perpetuities be deferred like annuities?
Yes.
What is an example of a perpetuity?
A common share.
Growth perpetuity
A growth perpetuity is where the cash flow increases each period at a constant rate for infinity.
