Go Back   The Finance Forums > Finance forums > Homework



Homework Get help with your finance related homework.

Reply
 
Thread Tools
  #1  
Old 10-12-2012, 07:44 PM
NWO NWO is offline
Junior Member
 
Join Date: Oct 2012
Posts: 2
Default Basic Annuity Valuation

Hi Everybody,

Here is a very simple problem that I can't solve for some reason.

The Question says that you will receive $500K semiannualy with an interest rate of 0,05. R=0,05 here is the annual rate so we need to find the semi-annual rate first before we go on. R/2=0,025.

The basic PV calculation for 4 periods yields an answer of $1,939,394.

PV> 500K/(1,025)^(0,5) + 500K/(1,025)^(1) + 500K/(1,025)^(1,5) +500K/(1,025)^(2)= $1,939,394.

This is ok and I understand it but when I put this into Annuity formula I dont get the same result for some reason.

My annuity formula is as follows;

PV(Annuity)= (500K/0,025)*[1-1/(1,025)^(4)]= $1,880,987

In Annuity formula above, I just thought that we have 2 periods in a year since we will get paid semi-annually and for 2 years, so this means we have in total 4 periods.

Where is the flaw here and why doesnt it yield the same result as simple discounting?

Thanks in advance
Reply With Quote

Old Sponsors
  #2  
Old 10-13-2012, 09:39 AM
ArcSine ArcSine is offline
Member
 
Join Date: Oct 2010
Location: North Carolina, USA
Posts: 89
Default Re: Basic Annuity Valuation

Since you're correctly expressing everything in terms of 6-month periods, then 2.5% is the rate per period (as you're using) but also each 6-month period is one whole period.

Hence you have 4 "whole" periods, each one of 6 months, and your simple discounting should be...

500 / 1.025^1 +
500 / 1.025^2 +
500 / 1.025^3 +
500 / 1.025^4

Make that simple change and you'll be back on track.
Reply With Quote

  #3  
Old 10-13-2012, 11:14 AM
NWO NWO is offline
Junior Member
 
Join Date: Oct 2012
Posts: 2
Default Re: Basic Annuity Valuation

Thank you for your reply. I appreciate it. Then I guess the book has a problem because it shows that the annual interest rate is adjusted accordingly for semi annual compounding but they forgot to adjust the top right?
Reply With Quote

Reply

Thread Tools

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off



» Boards




All times are GMT -4. The time now is 02:32 AM.


Powered by vBulletin® Version 3.8.5
Copyright ©2000 - 2018, Jelsoft Enterprises Ltd.