How does an ordinary annuity differ from an annuity due?

An ordinary annuity is characterized by payments that are made at the end of each period, while an annuity due involves payments that are made at the beginning of each period. This timing difference is significant because it impacts the present value and future value calculations of the annuities.

When payments are made at the end of the period, the first payment does not earn interest for that period, whereas with an annuity due, the first payment is made immediately and can earn interest for the entire period. As a result, the present value of an annuity due is typically higher than that of an ordinary annuity, assuming the same payment amount, interest rate, and period.

This distinction is crucial for financial decision-making, as it affects cash flow timing, investment returns, and valuation of the annuity over time. Understanding this difference helps in accurately evaluating financial products that involve annuities and assists in effective budgeting and planning.