Question

You are giving personal financial planning advice to your parents. Both of your parents have worked for Air New Zealand for 15 years. They have savings of $100,000 invested in Air New Zealand’s ordinary shares. They expect to be able to earn 6% compounded monthly on any investments or savings. Your parents wish to retire in 20 years. In retirement, they desire to have $5000 of monthly income for 25 years. At this point, they expect to die (or have you take care of them). Due to their great loyalty to Air New Zealand, they wish to invest their savings in Air New Zealand ordinary share

a. If an alternative investment opportunity becomes available that provides a 6.25% return compounded semi-annually (every six months), should they continue with their current savings account or switch to this alternative? Why?

b. In words only, tell your parents what mistake they are making by having all their savings in Air New Zealand.

Answer 1

Option A -

To find the best investment, we need to compare the returns using effective annual interest rate

= (1 + (nominal rate / number of compounding periods)) ^ (number of compounding periods) - 1

In case of 6% compunded monthly

= (1+(6%/12))^12-1

= 6.167%

In case of 6.25% compunded semi annually

= (1+(6.25%/2))^2-1

= 6.347%

6.25% compounded semi annually is higher than 6% compunded monthly

They should switch to alternative scheme as it is giving more returns than current savings account

Part B-

Please find below the mistakes:

1. Concentrated risk: They have invested all their assets into singe company which is risky for them. Any uncertainity regards to company can impair their assets. They should diversify their asset base to avoid the risk.

2. Human and Financial capital: They are working with Air New Zealand and also invested in this company. In case of any issues with the company, both capital will be at risk which can impair their livelihood and savings.