A:

An annuity is an investment in which a person receives a fixed sum of money annually. Coupon payments received by a bondholder are an example of an ordinary annuity because the amount of the payments is fixed, and the payments occur at the same time every period.

For example, consider an investor who purchases a 20-year government bond for $10,000. The bond has a coupon rate of 10%, and the investor receives the coupon payment at the end of each year. For the entire 20 years the investor holds the bond, he receives a fixed payment of $1,000 each December. At the end of the 20 years, when the bond matures, he turns in the bond and receives back his $10,000 principal payment.

Because his coupon payments are fixed and occur at the same time at the end of every year, they are an example of an ordinary annuity. While the definition of an annuity is a series of fixed yearly payments, this money can be distributed to the investor more frequently than once per year if the terms of the investment so stipulate. Some annuities, including bond coupon payments, are paid out semi-annually, quarterly or even as frequently as monthly. Returning to the bond example above, if its coupon payments were distributed quarterly instead of yearly, the investor, then, receives $250, or 2.5% percent of the principal amount, at the end of each quarter instead of $1,000, or 10% of the principal amount, at the end of each year.

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