An individual aged 50 recently bought an annuity. Which of the following best describes an annuity in the context of investments in securities?

• A. A contract that provides a series of periodic payments to the investor, typically after retirement, in exchange for an initial lump sum or series of payments.
• B. A government bond that pays interest only at maturity and is considered risk-free.
• C. A short-term debt instrument issued by corporations to raise capital, usually maturing in less than one year.
• D. A type of equity security that represents ownership in a corporation and entitles the holder to voting rights.

Answer: (A)

Verified step by step guidance

1. Step 1: Begin by understanding the concept of an annuity in the context of investments. An annuity is a financial product typically used for retirement planning, where an individual pays an initial lump sum or series of payments to an insurance company or financial institution.
2. Step 2: Recognize the key feature of an annuity: it provides a series of periodic payments to the investor, often starting after retirement. These payments can be fixed or variable, depending on the type of annuity purchased.
3. Step 3: Compare the description of an annuity with the other options provided in the question. For example, a government bond pays interest at maturity and is considered risk-free, but it does not involve periodic payments to the investor. Similarly, a short-term debt instrument like commercial paper is used for corporate capital raising and does not provide periodic payments.
4. Step 4: Eliminate the options that do not match the characteristics of an annuity. Equity securities represent ownership in a corporation and provide voting rights, which is unrelated to the concept of periodic payments after retirement.
5. Step 5: Conclude that the correct description of an annuity is: 'A contract that provides a series of periodic payments to the investor, typically after retirement, in exchange for an initial lump sum or series of payments.'