Question

Maybepay Life Insurance Co. is selling a perpetual annuity contract that pays $2,400 monthly. The contract currently sells for $332,000.

What is the monthly return on this investment vehicle?

What is the APR?

What is the effective annual return?

Answer 1

Solution:

1. Monthly return on this investment vehicle is calculated by using PV of a perpetuity equation.

                PV = C/r

PV = $332,000 ; C = $2,400

$332,000 = $2,400 / r

.r = $2,400 / $332,000

.r = 0.0072289 or 0.72%

2. Calculating APR

To calculate APR we multiply the interest rate by number of months in a year.

APR = 12 x 0.72%

        = 8.64%

3. EAR = [1 + (APR/m)]^m - 1

        = [1 + ( 0.0864 / 12 )¹² – 1

        = [1 + (0.0072) ¹² – 1

        = 1.0899 – 1

        = 0.0899 or 8.99%