An investor wishes to invest all of her $6.5 million in a diversified portfolio through a commercial lender. The types of investments, the expected annual interest rate for the investment, and the maximum allowed percentage of the total portfolio that the investment can represent are shown in the table below:

INVESTMENT EXPECTED INTEREST MAXIMUM ALLOWED

(% of total portfolio)

Low-income mortgage loans 7.40% 20%

Conventional mortgage loans 6.20% 25%S

Government sponsored

mortgage loans 8.00% 25%

Bond investments 4.45% 30%

Stock investments 7.50% 15%

Futures trading 8.90% 10%

She wants at least 40% of her total investment in non-mortgage instruments. Furthermore, she wants no more than 35% of her total investment to be in high-yield and high-risk instruments (i.e. expected interest rate of investment is 8% or greater). Formulate and solve this problem in Excel to determine how her money should be diversified in a manner which will meet the requirements and maximize the amount of interest income. (Hint: Make sure that the LHS and RHS of constraints are in terms of dollars not ratios)

1. Formulate the problem. (Hint: Set up total budget constraint as an equality (=) and not as inequality ().)
2. What is the expected total interest income generated from the investment strategy (the value of the objective function)?
3. Based on your solution, how much should be invested in each investment option?
4. Which options should she NOT invest if you she had more money?
5. If the return on bond investment increases to 6.1% how much investment in bond changes? Now try 6.3%. How much did it change? How do you explain the difference if any?
6. Using

V1 V2 Decision Variables O 0 Objective Function Coefficient Constraints: LHS Sign RHS Constraint #1 Constraint #2 Constraint #3