Which of the following is not true regarding an annuity due?
Select the correct response:
It is a series of equal cash flows.
Payments are made at the start of each period.
It is also known as deferred annuity.
Cash flows occur for a specific time.
The correct answer and explanation is :
Correct Answer:
It is also known as deferred annuity.
Explanation:
An annuity due is a type of annuity where payments are made at the beginning of each period rather than at the end. This timing difference is what primarily distinguishes an annuity due from an ordinary annuity, where payments are made at the end of each period.
Let’s evaluate each of the options to identify the incorrect statement:
- “It is a series of equal cash flows.”
✅ True. An annuity due involves equal payments made at regular intervals, just like any standard annuity. - “Payments are made at the start of each period.”
✅ True. This is the defining characteristic of an annuity due. For example, rent payments are typically made at the beginning of the month, making rent an example of an annuity due. - “It is also known as deferred annuity.”
❌ Not true. This is incorrect because a deferred annuity refers to an annuity where payments begin at a future date after a deferral period. In contrast, an annuity due starts payments immediately (at the beginning of each period). Therefore, they are distinctly different types of annuities and should not be confused with one another. - “Cash flows occur for a specific time.”
✅ True. Both annuity due and ordinary annuities have payments that occur for a defined period (e.g., monthly for five years). This distinguishes them from perpetuities, which last forever.
Summary:
An annuity due is not the same as a deferred annuity. While both involve scheduled cash flows, their timing and purpose differ. An annuity due is for immediate use, while a deferred annuity is structured to start later, often used for retirement planning. Recognizing this difference is important for accurately understanding financial products and their applications.