Financial Advice for TDFs (Target Date Funds) We have seen how households save and consume over the life cycle and how the profile of wages may affect saving and investment decisions. You will replicate some of these graphs under different hypothetical scenarios of life-cycle profiles. The main result that you should have in your mind is the Merton-Markowitz result. That is, if we have to make an asset allocation between stocks and bonds and the returns on stocks follow rst =+ st with the following assumptions: The mean return () does not depend on time t (and is constant at 6%) The error term st follows a normal process with a standard deviation () equal to 20% per annum The investor earns in the bond market a fixed r=2% with certainty (=0) Then with measuring aversion to risk we have =(-r)/*2 where =S/(S+B), that is is the share of the financial wealth invested in stocks (total financial wealth=B+S). Assume the investor has a wage increasing by 2% per annum from age 20 until 65 and then retires at 65 and earns a state pension (not modelled here) equal to 60% of the last salary (60% is also known as the replacement rate). The investor expects to live until 90. a). Compute the present value of remaining wage income over the life cycle (age 20-90) using r=2%, r=4% and r=6%. b). Assume that the investor wants to follow the Merton/Markowitz advice. erton and arkowitz however ignore how wages affect our investment decision. Assume that an investor with =3has decided to save 10% of wages every period until retirement and nothing from his retirement income and assume they view the certain salary as a riskless bond. During retirement the investor draws down wealth by consuming the wealth divided by the remaining years of life (if they expect to live for 10 years and have 100000 pounds, they consume 10000 pounds which are deducted from financial wealth). Please present in an excel spreadsheet your advice to this investor and discuss the economic intuition.