In: Finance
Question:
You recently received a bonus of $8,000 and are thinking of investing this sum of money for your retirement 20 years later. Sandy Chen, your financial planner, approached you recently an offered two investment products. Product Aee will earn an annual return of 5% per year for the first 5 years. If there is no recession in Singapore during the first 5 years, all amounts invested will earn an annual return of 7% for the next 10 years, otherwise, returns will be 3% per year. Alternatively, Product Bee allows you to invest $800 per year (at the beginning of each year) for the next 10 years. It will earn a return of 5% per year. This product will mature 20 years later. Over the next two decades, the deposit rate offered by local banks is expected to be 2% per year, which is compounded daily. Whereas, lending rates are expected to be 6% per year (compounded monthly). Based on a recent article you read from Business Times, economists have predicted that there will be a 70% chance of a recession happening over the next several years.
(a) Calculate the amount you expect to receive at the end of 15 years for Product Aee if there is no recession during the first 5 years.
(b) Calculate the amount you expect to receive at the end of 15 years for Product Aee if there is a recession during the first 5 years.
(c) Calculate the value of Product Bee on maturity. (d) Calculate the effective interest rate of both deposit and lending rates.
(d) Calculate the effective interest rate of both deposit and lending rates.
(e) Determine and justify which investment product you should choose. State any assumptions made.
(a) | Amount to be received after 15 years for Aee if there is no recession during first 5 years | ||||||||||||
For first 5 years | |||||||||||||
Pv | Deposit in the beginning | $8,000 | |||||||||||
Rate | Interest rate | 5% | |||||||||||
Nper | Number of years | 5 | |||||||||||
FV | Amount accumulated at end of 5 years | $10,210.25 | (using excel FV function with Rate=5%, Nper=5, Pv=-8000) | ||||||||||
Next 10 years | |||||||||||||
Pv | Amount available in the beginning | $10,210.25 | |||||||||||
Rate | Interest rate if there was no recession | 7% | |||||||||||
Nper | Number of years | 10 | |||||||||||
FV | Amount accumulated at end of 15 years | $20,085.11 | (using excel FV function with Rate=7%, Nper=10, Pv=-10210.25) | ||||||||||
(b) | Amount to be received after 15 years for Aee if there is recession during first 5 years | ||||||||||||
Next 10 years | |||||||||||||
Pv | Amount available in the beginning | $10,210.25 | |||||||||||
Rate | Interest rate if there was recession | 3% | |||||||||||
Nper | Number of years | 10 | |||||||||||
FV | Amount accumulated at end of 15 years | $13,721.73 | (using excel FV function with Rate=3%, Nper=10, Pv=-10210.25) | ||||||||||
.(c) | Value of product Bee on maturity | ||||||||||||
Pmt | Amount invested per year | $800 | |||||||||||
Rate | Interest Rate | 5% | |||||||||||
Nper | Number of years | 10 | |||||||||||
FV | Amount accumulated at end of 10 years | $10,565.43 | (using excel FV function with Rate=5%, Nper=10, Pmt=-800,Type=1(Beginning of year deposit) | ||||||||||
Next 20years: | |||||||||||||
Interest rate =2% compounded daily | |||||||||||||
Rate | Annual effective rate=((1+(0.02/365))^365)-1 | 0.02020078 | |||||||||||
PV | Amount available in the beginning of 20 year period | $10,565.43 | |||||||||||
Nper | Number of years | 20 | |||||||||||
Fv | Value of product Bee on maturity | $15,761.60 | (using excel FV function with Rate=0.02020078, Nper=20,Pv=-10565.43) | ||||||||||
Effective deposit Rate | 0.02020078 | ||||||||||||
Effective deposit Rate(Percentage) | 2.020078% | ||||||||||||
Lending rate 6% compounded Monthly | |||||||||||||
Effective Lending rate=((1+(0.06/12))^12)-1= | 0.06167781 | ||||||||||||
Effective Lending rate(Percentage)= | 6.17% |
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