Problem:
Terry Evans is a financial analyst who specializes in designing retirement income portfolios for retirees using corporate bonds. He has just completed a consultation with the client who expects to have $750,000 in liquid assets to invest when she retires next month. Terry and his client agreed to consider upcoming bond issues from the following six companies.
| Company |
Return
|
Years to Maturity
|
Rating
|
|
Acme Chemical
|
8.65%
|
11
|
1-Excellent
|
|
DynaStar
|
9.50%
|
10
|
3-Good
|
|
Eagle Vision
|
10.00%
|
6
|
4-Fair
|
|
MicroModeling
|
8.75%
|
10
|
1-Excellent
|
|
OptiPro
|
9.25%
|
7
|
3-Good
|
|
Sabre Systems
|
9.00%
|
13
|
2-Very Good
|
The column labeled "Return" in this table represents the expected annual yield on each bond, the column labeled "Years to Maturity" indicates the length of time over which bonds will be payable, and the column labeled "Rating" indicates an independent underwriter's assessment of the quality or risk associated with each issue.
Terry believes that all the companies are relatively safe investments. However, to protect his client's income, Brian and his client agreed that no more than 25% of the money should be invested in any one investment and at least half of her money should be invested in long-term bonds which mature in ten or more years. Also, even though DynaStar, Eagle Vision, and OptiPro offer the highest returns, it was agreed that no more than 35% percent of the money should be invested in these bonds since they also represent the highest risks (i.e., they were rated lower than "very good").
Required:
Terry needs to determine how to allocate his client's investments to maximize her income while meeting their agreed upon investment restrictions.
Assume that Terry re-invests into a bond when it matures. The expected annual yield does not change for each bond. This will avoid the need to consider any NPV analysis that can alter the allocation. Solve the problem and show all work.