QUESTION 4 (10 MARKS) A retired couple requires an annual return of $2,000 from investment of $20,000. There are 3
options available:
(A) Treasury Bills yielding 9%;
(B) Corporate bonds 11%;
Junk Bonds. 130%
How much should be invested in each to achieve their goal? Give 3 sets of options that can
achieve their goal.[10 Marks]

  (T, C, J) = (in dollars)

     (10000, 10000, 0),

     (15000, 4915.97, 84.03),

     (18181.82, 1680.67, 137.51)

Step-by-step explanation:

There are a number of ways to approach this question. We have chosen an approach that determines the investments required to achieve interest rate targets.

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For an overall interest rate of I, the proportion that must be invested at rate I1 < I < I2 is ...

  proportion at I1 = (I2 -I)/(I2 -I1)

Similarly, the proportion that must be invested at I2 is what's left over. It can be computed similarly:

  proportion at I2 = (I -I1)/(I2 -I1)

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We want an overall interest rate of $2000/$20000 = 10%.

Given available interest rates of 9%, 11%, and 130%, we need to have investments at a rate lower than 10% and at a rate higher than 10%.

If we use only the options for 9% and 11% (no junk bonds), then we can compute ...

  proportion at 9% = (11 -10)/(11 -9) = 1/2

  proportion at 11% = (10 -9)/(11 -9) = 1/2

1st Option:

  $10,000 in treasury bills; $10,000 in corporate bonds

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Suppose we want to achieve a 13% return on our investments at 11% and 130%. Then the proportion invested at 9% will use this value for I2:

  proportion at 9% = (13 -10)/(13 -9) = 3/4

Of the remaining 1/4 of the money, we can achieve a 13% return by mixing the investments like this:

  proportion at 11% = (130 -13)/(130 -11) = 117/119

  proportion at 130% = (13 -11)/(130 -11) = 2/119

2nd option:

  $20,000 × 3/4 = $15,000 in treasury bills

  $5000 × 117/119 = $4,915.97 in corporate bonds

  The remaining amount, $84.03 in junk bonds

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Let's suppose we want a 20% return on our investment in junk bonds and corporate bonds. Then the proportion of the money invested at 9% will be ...

  proportion at 9% = (20 -10)/(20 -9) = 10/11

And the proportion at 11% will be ...

  proportion at 11% = (130 -20)/(130 -11) = 110/119 . . . (of the remaining 1/11 of the funds)

3rd option:

  $20,000 × 10/11 = $18,181.82 in treasury bills

  $1,818.18 × 110/119 = $1,680.67 in corporate bonds

  The remaining amount, $137.51 in junk bonds

Additional comment

The most that could be invested in Junk Bonds is $165.29. If the remainder is invested in Treasury Bills, then the overall return will be $2000. (You could consider this to be a 4th option.)

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step-by-step explanation:

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step-by-step explanation: