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Old 07-29-2012, 06:28 AM
helpneeded helpneeded is offline
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Default Annuity every other year Q- plz help

Hi, can someone help me understand how to solve this?

a. Calculate the present value of an annuity that makes a payment of $1,000,000 every other year for 10 payments with the first payment being made exactly two years from now. Hint: Use the standard annuity formula, but let the “period” be two years (rather than just one year) and use the effective two-year rate implied by the annual effective rate of 5 percent.
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Old 07-30-2012, 08:28 AM
ArcSine ArcSine is offline
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Default Re: Annuity every other year Q- plz help

The setup is that you have a 5-period, 5-payment annuity. First payment is at the end of the first (2-year) period; hence, you'll wanna use the shortcut formula for an "ordinary" annuity.

The only wrinkle is that you'll need to first determine the per-period rate. For this, think of it as being the two-year rate which would make someone indifferent between investing a dollar for two years at this two-year rate, vs. investing that same dollar for two consecutive one-year periods.

If the one-year rate is r, someone investing for two consecutive years would end up with (1 + r)^2 dollars at maturity. Hence, they'd be just as happy to get into a 2-year deal which offered a one-period (2-year) rate of (1 + r)^2 - 1.

Take it from here?
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