Question
A 65-year old female client is considering either purchasing a single-premium insurance policy or investing in a tax-free municipal bond. The fundamental feature of this
A 65-year old female client is considering either purchasing a single-premium insurance policy or investing in a tax-free municipal bond. The fundamental feature of this insurance policy is that the premium is paid all at once when the policy is written, and this one-payment feature does not run afoul of any tax codes. In her case, each dollar of premium generates 3.6914 dollars of insurance to be paid at her death. On the other hand buy now and hold until death investment strategy in tax-free municipal bonds gives return at annual rate of 7.1% (and all of the dividends associated with these bonds can be reinvested at this rate). Thus, in two years the bonds would be worth (1.071)2 = 1.147 dollars per each dollar invested, and, e.g., in 12.5 years they would be worth (1.071)12.5 = 2.357 dollars per each dollar invested. The worksheet Residual Life describes the random variable R representing the residual life of 65-year old females (residual life is the number of years till her death), according to the official government statistical data. To simplify for the purposes of this question, all deaths are assumed to occur half way through the year. That is, if she dies between today and her 66th birthday, R = 0.5. If she dies between her 68th and 69th birthday, R = 3.5
1) If the investment objective is to maximize the expected amount of money on hand at the time of her death, which of the two investment strategies would you recommend for this client? (You should ignore any potential tax effects and assume that the probability of default is zero for both investments.)
A) purchasing insurance policy
B) investing in tax-free municipal bonds (buy and hold)
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