What Is Ordinary Annuity? How Does It Work?
An annuity is an agreement that guarantees a series of payments over a specific time so what is ordinary Annuity? Two different forms of annuity are the ordinary annuity and the second is annuity due. Today let us know everything about Ordinary Annuity.
What Is Ordinary Annuity?
An ordinary annuity is an annuity where the payment is made at the end of every interval period. For example, the ordinary annuity that is of a monthly interval will make the payments at the end of every month.
The payments in an ordinary annuity can be made weekly but most commonly are made monthly, quarterly, semi-annually, and also annually.
It is different that is opposite of the annuity due where the payment is made at the beginning of every interval. But the annuities are different from each other yet related.
Define Ordinary Annuity
The ordinary annuity is defined as a sequence of an equal amount of payments that are made at the end of every consecutive period throughout the fixed length of time. The payments can be made in weeks also but in general, they are made monthly, quarterly, half-yearly, and yearly.
Ordinary Annuity Examples
Here is some example of the annuities where the payment is made at the end of the interval or period.
- Home mortgages
- Income annuities
- Dividend payments
How Does Ordinary Annuity Work?
The present value of an ordinary annuity depends on the usual interest rate. The present value of an ordinary annuity is decreased due to the time value of money and the declining interest rates increase in the present value. This happens because the value of the annuity is based on the return that the money could earn from somewhere else. So if you get a high interest rate from somewhere else then the value of the annuity goes down.
Ordinary Annuity Present Value Calculation
In the ordinary annuity formula, the present value is calculated as follows with three variables.
PMT = Period Cash Payment
r = Interest rate per period
n = total number of periods
Present Value = PMTx ((1-(1+r)^-n)/r)
So for example the ordinary annuity is $ 50,000 per year for 5 years and 7% is the interest rate.
Preent Value = 50000 x((1-(1+0.07)^-5)/0.07) = 205010
So here present value of ordinary annuity is $ 205,010
What Is The Difference Between An Annuity And An Ordinary Annuity?
In an annuity, the payments are made at regular intervals whereas in an ordinary annuity the payments are made at the end of every period, and in an annuity due the payments are made at the very beginning of every period
What Is An Ordinary Annuity Formula?
The ordinary Annuity Formula is referred to as the formula that is used to calculate the present value of payments made in a specific period. Present Value = PMTx ((1-(1+r)^-n)/r (Here PMT = Period Cash Payment, r = Interest rate per period, n = total number of periods)
What Is The Present Value Of An Ordinary Annuity?
Present Value = PMTx ((1-(1+r)^-n)/r (where the PMT = Period Cash Payment, r = Interest rate per period, n = total number of periods)
Is Ordinary Annuity Or Annuity Due Better?
As the payments are made early in the annuity due then made in an ordinary annuity the present value of the annuity due is higher.
But when the interest rate goes up the value of ordinary annuity goes down and when the interest rates come down the value of ordinary annuity rises.
Now you know that in what is ordinary annuity the payment is made in the end. So in an ordinary annuity the party that makes the payment gains benefit. Whereas in an annuity due party receiving the payment is a benefit. Hope you have understood all about what is ordinary annuity and how it works?