Question

Which of the following statements regarding annuities is NOT CORRECT?

a. The general assumption in finance is that annuity payments occur at the end of the period, so this type of payment is referred to as an ordinary annuity.
b. If the interest rate is greater than zero, then the future value of an ordinary annuity is greater than the future value of an annuity due. This occurs because the last payment of the ordinary annuity earns interest, while the last payment of the annuity due does not.
c. An annuity is a recurring payment, at set intervals, for a given amount of time.
d. An annuity due is like an ordinary annuity with the exception that payments occur at the beginning of each period, instead of at the end of each period.

Answer 1

The incorrect statement is that the future value of an ordinary annuity is greater than that of an annuity due; in reality, the future value of an annuity due is greater because each payment earns interest for one additional period.

Step-by-step explanation:

The statement regarding annuities that is NOT CORRECT is: "If the interest rate is greater than zero, then the future value of an ordinary annuity is greater than the future value of an annuity due. This occurs because the last payment of the ordinary annuity earns interest, while the last payment of the annuity due does not." The correct concept is that if the interest rate is greater than zero, the future value of an annuity due is actually greater than the future value of an ordinary annuity because each payment of the annuity due earns interest for one additional period compared to the ordinary annuity.

To clarify the terms: An ordinary annuity is when payments are made at the end of each period, whereas with an annuity due, payments are made at the beginning of each period. Both types of annuities involve periodic payments for a certain period and are commonly used in retirement planning and pension schemes. However, due to the timing of payments, the valuation and future value of these annuities differ.