Question

You have the option of two equally risk annuities, each paying RM5,000 per year for eight years. One is an annuity due and the other is an ordinary annuity. If you are going to be receiving the annuity payments, which annuity would you choose to maximize your wealth?

Select one:

a. the annuity due.

b. either one because they have the same present value.

c. Since we don't know the interest rate, we can't find the value of the annuities and hence we cannot tell which one is better.

d. the ordinary annuity.

Answer 1

An ordinary annuity receives payments at the end of every year where as annuity due receive payments at the beginning of the year. If these annuities are discounted at the required rate to calculate the present value the annuity due would have a higher present value as compared to the ordinary annuity. Hence, an investor who has an option of two equally risky annuities, each paying RM 5,000 per year for 8 years should select and annuity due in place of an ordinary annuity.

To maximize your wealth you would choose-

A. The annuity due.

Do let me know in the comment section in case of any doubt.