You are comparing two annuities which offer quarterly payments of $2,500 for fiv

Question

You are comparing two annuities which offer quarterly payments of $2,500 for five years and pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while annuity B will pay you on the last day of each month. Which one of the following statements is correct concerning these two annuities?
Question 6 options:
1) These two annuities have equal present values as of today and equal future values at the end of year five.
2) These two annuities have equal present values but unequal futures values at the end of year five.
3) Annuity A has a smaller future value than annuity B.
4) Annuity B is an annuity due.
5) Annuity B has a smaller present value than annuity A.

Explanation / Answer

The last statement is correct. Annuity A has a higher present value (PV) because it will start making payments earlier than annuity B. The time value of money (TVM) principle basically says that a dollar today is more valuable than a dollar tomorrow. Even though annuities A and B will pay equal amounts in cash flow, the fact that the cash flow comes sooner with annuity A than annuity B gives annuity A a higher PV.

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