You Are Considering Two Equally Risky Annuities, Each of Which

question 93

Multiple Choice

You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT?

• A) A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
• B) The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
• C) The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
• D) The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.

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Definitions:

A Credit Rating

This is an evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt and an implicit forecast of the likelihood of the debtor defaulting.

Note

Unsecured debt, usually with a maturity under 10 years.

Protective Covenant

A clause in a financial contract that restricts certain actions of the borrower to protect the lender's interests.

Liquidity Premium

The additional return investors demand for holding a security that is not easily convertible into cash without loss of value.