Question
Martin is looking for an investment which will mature in five years and plans to use the amount to finance his daughters university education. He
Martin is looking for an investment which will mature in five years and plans to use the amount to finance his daughters university education. He estimates he will need $500,000 in expenses at that time for his daughters education expenses. His financial advisor presents him with a 5- year structured deposit A. It will earn 1% per annum for the first two years, stepping up to 2% in the 3rd year and 3% in the last 2 years.
(a) His financial advisor presents another structured deposit, B, which has the same return profile but whose return depends additionally on the performance of 3 stocks X, Y, and Z. He will get an additional 5% return at maturity if the prices of all 3 stocks are 10% higher than today. How much does Martin have to pay for this second structured deposit, assuming that all of the 3 stocks are 10% higher at maturity? He still receives $500,000 at maturity. Calculate the average annual return of investment B. In this case, which investment would you recommend, A or B? Justify your choice
(b) an alternative investment C which is a 5-year annuity of $105,000 each year with an interest rate of 2.5% per annum. How much will this investment cost today? If the annual cash flows of $105,000 are reinvested each year at 2.5%, will this be enough to fund Martins daughters education in 5 years time?
(C) A fourth investment, D, which is structured to mature with a value of $500,000 at the end of five years and has no interim cash flows, earns 0.45% every quarter. Would this investment be more attractive than the other 3? Support your conclusion with appropriate calculations.
(D) What are the assumptions made when we compared the attractiveness of all these 4 investments?
Please help with questions (C) and (D).
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