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Investment Problem Presentation

Brian Givens needs to allocate $750,000 of a client's retirement funds across six bond options to maximize annual return while meeting constraints. He defines decision variables X1-X6 for the amount invested in each bond. The objective is to maximize total annual return calculated by multiplying each investment by its return rate. Constraints include investing the full $750,000, limiting any single investment to 25% of the total, and requiring minimum investments in long-term and low-risk bonds. Brian uses Excel Solver to find the optimal investment amounts across the six bonds.

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marichu apilado
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677 views

Investment Problem Presentation

Brian Givens needs to allocate $750,000 of a client's retirement funds across six bond options to maximize annual return while meeting constraints. He defines decision variables X1-X6 for the amount invested in each bond. The objective is to maximize total annual return calculated by multiplying each investment by its return rate. Constraints include investing the full $750,000, limiting any single investment to 25% of the total, and requiring minimum investments in long-term and low-risk bonds. Brian uses Excel Solver to find the optimal investment amounts across the six bonds.

Uploaded by

marichu apilado
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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INVESTMENT PROBLEM

- There are numerous problems in the area of finance to which we can


apply various optimization techniques.

-The main goal is to maximize the return on an investment while meeting


certain cash flow requirements and risk constraints.

-Alternatively, we might want to minimize the risk on an investment while


maintaining a certain level of return.
PROBLEM

Brian Givens is a financial analyst for Retirement Planning Services, Inc.


who specializes in designing retirement income portfolios for retirees
using corporate bonds. He has just completed a consultation with a
client who expects to have $750,000 in liquid assets to invest when she
retires next month. Brian and his client agreed to consider upcoming
bond issues from the following six companies:
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 the bonds will be payable, and
the column labeled “Rating” indicates an independent underwriter’s
assessment of the quality or risk associated with each issue.
Brian believes that all of the companies are relatively safe investments.
However, to protect his client’s income, Brian and his client agreed that
no more than 25% of her money should be invested in any one
investment and at least half of her money should be invested in long-
term bonds that 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% of the money should be
invested in these bonds because they also represent the highest risks
(i.e., they were rated lower than “very good”).
Brian needs to determine how to allocate his client’s investments to
maximize her income while meeting their agreed-upon investment
restrictions.
3.9.1 DEFINING THE DECISION VARIABLES
In this problem, Brian must decide how much money to invest in each
type of bond. Because there are six different investment alternatives, we
need the following six decision variables:
We can let:
• X1 = amount of money to invest in Acme Chemical
• X2 = amount of money to invest in DynaStar
• X3 = amount of money to invest in Eagle Vision
• X4 = amount of money to invest in MicroModeling
• X5 = amount of money to invest in OptiPro
• X6 = amount of money to invest in Sabre Systems
3.9.2 DEFINING THE OBJECTIVE FUNCTION

The objective in this problem is to maximize the investment income for


Brian’s client. Because each dollar invested in Acme Chemical (X1)
earns 8.65% annually, each dollar invested in DynaStar (X2) earns
9.50%, and so on, the objective function for the problem is expressed as:

MAX: .0865X1 + .095X2 + .10X3 + .0875X4 + .0925X5 + .09X6 }


total annual return
3.9.3 DEFINING THE CONSTRAINTS
Again, there are several constraints that apply to this problem. First, we must
ensure that exactly $750,000 is invested.
1) X1 + X2 + X3 + X4 + X5 + X6 = 750,000
Next, we must ensure that no more than 25% of the total is invested in any one
investment. Twenty-five percent of $750,000 is $187,500. Therefore, Brian can
put no more than $187,500 into any one investment. The following constraints
enforce this restriction:
2) X1 ≤ 187,500
3) X2 ≤ 187,500
4) X3 ≤ 187,500
5) X4 ≤ 187,500
6) X5 ≤ 187,500
7) X6 ≤ 187,500
3.9.3 DEFINING THE CONSTRAINTS
Because the bonds for Eagle Vision (X3) and OptiPro (X5) are the only ones that
mature in fewer than 10 years, the following constraint ensures that at least half
the money ($375,000) is placed in investments maturing in ten or more years:
8) X1 + X2 + X4 + X6 ≥ 375,000

Similarly, the following constraint ensures that no more than 35% of the money
($262,500) is placed in the bonds for DynaStar (X2), Eagle Vision (X3), and
OptiPro (X5):
9) X2 + X3 + X5 ≤ 262,500

Finally, because none of the variables in the model can assume a value of less
than zero, we also need the following nonnegativity condition:
10) X1, X2, X3, X4, X5, X6 ≥ 0
3.9.4 IMPLEMENTING THE MODEL: LP MODEL
MAX: .0865X1 + .095X2 + .10X3 + .0875X4 + .0925X5 + .09X6 } total annual return

Subject to:
1) X1 ≤ 187,500 } 25% restriction per investment
2) X2 ≤ 187,500 } 25% restriction per investment
3) X3 ≤ 187,500 } 25% restriction per investment
4) X4 ≤ 187,500 } 25% restriction per investment
5) X5 ≤ 187,500 } 25% restriction per investment
6) X6 ≤ 187,500 } 25% restriction per investment
7) X1 + X2 + X3 + X4 + X5 + X6 = 750,000 } total amount invested
8) X1 + X2 + X4 + X6 ≥ 375,000 } long-term investment
9) X2 + X3 + X5 ≤ 262,500 } higher-risk investment
10)X1, X2, X3, X4, X5, X6 ≥ 0 } nonnegativity conditions
3.9.4 SOLVING USING EXCEL SOLVER
3.9.4 SOLVING USING EXCEL SOLVER
3.9.6 ANALYZING THE SOLUTION
The solution shown in Figure 3.22 indicates that the optimal investment plan places the
following:
• $112,500 in Acme Chemical (X1),
• $75,000 in DynaStar (X2),
• $187,500 in Eagle Vision (X3),
• $187,500 in MicroModeling (X4),
• $0 in OptiPro (X5), and
• $187,500 in Sabre Systems (X6).
It is interesting to note that more money is being invested in Acme Chemical than
DynaStar and OptiPro even though the return on Acme Chemical is lower than on the
returns for DynaStar and OptiPro. This is because DynaStar and OptiPro are both
“higher-risk” investments and the 35% limit on “higher-risk” investments is a binding
constraint (or is met as a strict equality in the optimal solution).
Thus, the optimal solution could be improved if we could put more than 35% of the
money into the higher-risk investments.

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