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Calculation of Annuities

This document discusses the calculation of annuities and sinking funds. It defines annuities as contracts between an individual and insurance company where the individual makes a lump sum payment in exchange for guaranteed income, asset growth, death benefits, or long term care benefits. There are two main types of annuities: fixed annuities which guarantee principal amounts, and variable annuities where principal is not fixed and fees are higher. Sinking funds are accumulated funds from business earnings or government revenue used to repay long term debt or cover depreciation. Formulas are provided to calculate future value of annuities and periodic contributions required for sinking funds based on factors like principal amount, interest rate, number of periods, and expected fund

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59 views2 pages

Calculation of Annuities

This document discusses the calculation of annuities and sinking funds. It defines annuities as contracts between an individual and insurance company where the individual makes a lump sum payment in exchange for guaranteed income, asset growth, death benefits, or long term care benefits. There are two main types of annuities: fixed annuities which guarantee principal amounts, and variable annuities where principal is not fixed and fees are higher. Sinking funds are accumulated funds from business earnings or government revenue used to repay long term debt or cover depreciation. Formulas are provided to calculate future value of annuities and periodic contributions required for sinking funds based on factors like principal amount, interest rate, number of periods, and expected fund

Uploaded by

jo
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CALCULATION OF ANNUITIES

DEFINITION
It is a contract between you and 3rd party (usually on insurance company) whereby in exchange of
making a lump-sum payments, the insurance company promises to do four things.
 Provide on income for certain period of time or for life
 Provide for accumulation or asset growth
 Provide death benefit
 Provide for long term care benefits
TYPE OF ANNUITIES
 Fixed annuities
 Variable Annuities
FIXED ANNUITIES:-
In this principal amount is fixed, it is guaranteed by insurance company. These are good options for
conservative individuals and are not regulated as an investment, but an insurance product only.
VARIABLE ANNUITIES:
In the principal payments are not fixed this type of annuities or investment typically has higher fees
and expenses because of additional insurance of insurance component.
CLASSIFICATION OF ANNUITY
 Future value
 Present Value
CALCULATION OF FUTURE VALUE
( )
FV= C [ ]
C= Cash flow per period
I= Interest rate
N= Number of payment

SINKING FUNDS
Definition: A fund accumulated out of a business enterprises earning or a government’s revenue and
invested to repay a long term debt or to meet depreciation charge

BENEFITS OF SINKING FUNDS


 It provides issues with security against future business conditions.
 The insurance provide by sinking fund decrease the interest rates therefore the interest
expenses. It may increase cash flow.
 The issuer can book capital gains on debt retirement if it purchases binds in the open market
below book value.
 Sinking fund enhances the tax benefits of financial leverage.

Bankexamstoday.com Page 1
CALCULATION OF SINKING FUND
FORMULAS:

Periodic contribution to sinking fund= ( )

FOR EXAMPLES
A company issued 5 million bonds at Rs. 100 per value of each bond at 8% coupon rate and maturing
15 years semi annual payments are to be paid to the fund which is expected to earn 5% p.a. find
amount of required periodic contribution.
Sol:
FV= 5 million 100
= 500000000
As payments are semi annual so interest rate= 5% 2
= 2.5%
Number of Period= 2 15
= 30

Periodic contribution to SF=


( )

= Rs. 11,388,820

So the company must deposit Rs. 11,388,820 at the end of each 6 months for 15 years to have
enough fund at the time of maturity.

Bankexamstoday.com Page 2

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