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I don’t quite seem to understand the illustration for Advanced annuities.
The question goes as follows:
A 5-year $600 annuity is starting today. Interest rates are 10%. Find the PV of the annuity.The answer is:
PV = 600 + 600 x 3.17 = 600 + 1902 = $2,502
or alternatively
PV = 600 x (1 + 3.17) = 600 x 4.17 = $2,502What I lack to understand how do you come up with the figure of 3.17? What does it stand for?
I would hardly call this an ‘advanced annuity’ – it is a basic Paper MA (was F2) question 🙂
Annuity factors give the PV when the first flow is in 1 years time and the 3.17 is the discount factor for a 4 years annuity at 10% that is given in the annuity tables that you are provided with in the exam.
We need the 4 year annuity factor because since the first flow is ‘today’, the 5 years of flows are at time 0 and at times 1 to 4.
I do suggest that you watch my Paper MA lectures on discounting because I explain everything needed to do with annuities (and there is nothing extra needed on annuities in Paper FM).
In future, if you want me to answer then ask in the Ask the Tutor Forum. This forum is for students to help each other.
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