Mathematics Investment: Advice on the Best Financial Investment Option to Invest $400 000 - Assignment Example

Report on Investment Strategies Name Professor Institution Course Date Introduction Investments can be categorised into personal investments, stock market investments, real estate investments, and business investments. In personal investments, we save money in a bank and get interest on the investment, like in term deposits. Stock market entails investing money in stocks and the profits or losses out of it depend on the performance of the market. Real investments encompass real assets, like buying a house, machinery or car. Financial investment covers the investment of funds in buying shares, bonds or mutual funds, which are financial assets. Also, business investments involve investing money in personal businesses. The purpose of this report is to advice on the best financial investment option to invest $400 000. The investment options considered are term deposit and stock market. The report considers a person who has just collected $500 000, from a distant Nigeria relative. He had spent $100 000 on celebrations, and gifts to favourite charities and he is to invest $400 000. Option 1: Term Deposit. Under this option, the amount invested in held at a chosen financial institution for a fixed period. The period can be short term or long term. The leader purchases a term deposit and can only withdraw after the expiry of the agreed term. Term deposit is exceedingly safe, therefore, appealing to a low-risk investor. However, withdrawals before maturity will attract a small interest rate, and at times small penalties. To invest in Heritage Bank, Suncorp Bank, or Common Wealth Bank, all based in Australia, the following general information is available: The three banks will pay a reduced interest rate for early maturity, and may attract some penalties for early withdrawals. There are no monthly accounts’ keeping fees. Heritage Bank does not attract set up fee on term deposits. The minimum amount to invest in Heritage is $1,000.00, and the maximum is $2,000,000.00. For Suncorp Bank, the minimum amount to invest is $ 10,000.00, and the maximum is $24,999.00. The minimum amount for Common Wealth is $50,000.00, and the maximum is $1,999,999.00. Common Wealth attracts $30 administration fee for early withdrawal. Thus, this information clearly shows that Heritage bank and Common wealth banks stand a higher chance for lumpsum investment of $400,000 as this sum falls within their minimum and maximum amounts. Summary of the Interest Rates and the Yields for Investing $400,000.00 Investment Term (Years) 1 5 10 15 20 Rates Heritage 5.3% 5.5% 5.5% 5.5% 5.5% Suncorp 5.1% 5.4% 5.4% 5.4% 5.4% Common Wealth 5.5% 5.7% 5.7% 5.7% 5.7% Amount ($) Heritage 421,200.0000 522,784.0026 683,257.7833 892,990.5969 1,167,102.996 Suncorp 26,273.949 32,518.1396 42,298.8680 55,021.4207 71,570.6323 Common Wealth 422,200.0000 527,758.1247 696,321.5954 918,723.4484 1,212,157.4110 Interest ($) Heritage 21,200.0000 122,784.0026 283,257.7833 492,990.5969 767,102.996 Suncorp 1,274.9490 7,519.1396 17,299.8680 30,022.4207 46,571.6323 Common Wealth 22,200.0000 127,758.1247 296,321.5954 518,723.4484 812,157.4110 Table 1 Assumptions The assumptions made are that the bank should not go bankrupt. For each bank, the interest rate of five years is the interest rate of 10 years, 15 years, and 20 years. We further assume that no withdrawals until maturity and the monetary policies of Australia do not affect term deposits. Note 1: a. The principal for Heritage bank and Common wealth bank are $400,000 whereas the principal, for Suncorp bank is $24,999. For Suncorp, the maximum amount that can be invested under term deposit is $24,999. b. All the workings for Table 1 are in Appendix 1. The key strengths of term deposit are the interest rates fixed for the investment duration. It is less risky than shares, and real estate investments. It helps one to stop dipping into savings because there is a fee charged if one breaks the term. Also, rolling over the term deposits attracts additional benefits or compound interest-earning interest on interest. However, the weakness associated with term deposit is that one may roll over from a high to a low interest rate. Investment Decision From Table 1, the cash inflows for Common wealth bank are more than those of Suncorp and Heritage bank. Therefore, in making capital investment decisions, we use Internal Rate of Return (IRR) analysis method to arrive at a viable investment. From Appendix 2, the IRR is 11.2%. This value is higher than the rate of return. Therefore, it is advisable to invest $400,000 in Common wealth bank, compounded with the fact that it has higher rates of return across the terms as compared to Heritage and Suncorp banks. Option 2: Stock Market. A stock market involves buyers and sellers trading company stock for a given price. The word, “stock” simply refers to a supply of money a company has collected from individuals or organizations. If one buys stock, he owns a portion of a company. This portion is a “share.” Individuals who own stocks are "stockholders" or “shareholders". Shareholders anticipate sharing profits. In the stocks, DUET Group (DUE), Spark Infrastructure Group (SKIDA), and Telecom Corporation of New Zealand (TEL) are the top performing companies. We shall consider investing $400,000.00 in them. The summary of the Dividends Accrued from the above Top Three Performing Companies Investment Duration (Years) 1 5 10 15 20 Accrued Dividends DUET 47,600 238,000 476000 714,000 952,000 SKIDA 45,599.97 227,999.85 455,999.70 683,999.55 911,999.40 TEL 42,399.97 211,999.83 423,999.76 635,999.65 847,999.53 Table 2 Note 2: a. The calculations for arriving at the dividends shown in Table 2 above have assumed a lumpsum investment of $400,000.00 in the three companies considered. b. All the calculations for Table 2 above are in Appendix 4 c. The dividend values in the Table 2 above are in $. Investment Decision From Table 2, DUE Company has higher dividends than SKIDA, and TEL. In making an investment decision, we should further consider the Internal Rate of Return (IRR). From Appendix 3, the IRR for DUE is 15.76%. Since this IRR is higher than dividend yield of 11.9%, investment in this company is viable. Therefore, if the stocks would be the option to take, then DUE would be the most preferred company for which to buy shares. Stock market has strengths associated with it. For example, investors have the ability to diversify into virtually any industry. They also enjoy tax benefits, the advantage of appreciation of shares, and ability to grow quickly in terms of finances. Assumptions made in the calculations 1. Market volatility The calculations have assumed there is no volatility in the financial market. However, in any investment, one expects higher chances in financial volatility to be associated with higher risks as in the case of stocks. Therefore, investors who do not like fluctuations in value will tend towards investments which have low risks but also lower potential returns. 2. Political Stability These calculations have also assumed the impact of politics on the stock markets. For prosperity in any economy, fruitful policies and reform measures should be implemented for a long time. 3. Values, Rates, and Costs. The values and rates used are current rates, values, and costs. It is an assumption that they reflect what the future stock market will be like. However, this will mainly be determined by the market forces affecting each company. The weakness of shares in investments is that they have higher risks and that it is difficult to predict these risks. Some of the expenses associated with stocks include: capital gains tax, securities transaction tax, and brokerage fee. Investment Options for Short Term and Long Term For short term, it is viable to invest in term deposits since they have low risks as compared to the financial volatility of shares. However, for long term, stock market is a viable option to invest since it has higher returns than term deposits. Besides, the financial volatility of shares is offset for longer investment durations. Appendix 1 Formula: Where: Future value, that is, the amount after investing money for a given term The present value, that is, the principal to invest The term deposit interest rates The duration the term deposit takes Heritage bank The interest rates are 5.3%, 5.5%, 5.5%, 5.5%, and 5.5% for a year, 5 years, 10 years, 15 years, and 20 years respectively. The principal to invest is $400,000.00. Therefore, in a year, Substituting the values for and for subsequent years becomes $522784.0026, $683257.7833, $ 892990.5969, and $1167102.9960, whereas interests become $122784.0026, $283257.7833, $492990.5969, and $767102.9960 for 5 years, 10 years, 15 years, and 20 years respectively. Commonwealth Bank Its interest rates are 5.5%, 5.7%, 5.7%, 5.7%, and 5.7% for a year, 5 years, 10 years, 15 years, and 20 years respectively. The principal to invest is $400,000.00. Therefore, in a year, , and Substituting the values for and for subsequent years becomes $527758.1247, $696321.5954, $918723.4484, and $1212155.4110, whereas interests become $127758.1247, $296321.5954, $518723.4484, and $812157.4110 for 5 years, 10 years, 15 years, and 20 years respectively. Suncorp Bank The interest rates are 5.1%, 5.4%, 5.4%, 5.4%, and 5.4% for a year, 5 years, 10 years, 15 years, and 20 years respectively. The principal to invest is $24,999.00. Therefore, in a year, , and . Substituting the values for and for subsequent years becomes $32,518.1396, $42,298.8680, $55,021.4207, and $71,570.6323, whereas interests become $7,519.1396, $17,299.8680, $30,022.4207, $46,571.6323 for 5 years, 10 years, 15 years, and 20 years respectively. Appendix 2 Computing Internal Rate of Return (IRR) for Common Wealth Bank Solution Where: The present value (cost) , are cash inflows for year year Rate of return Number of years Let 1st choice 10% When choosing a higher rate of 12% Therefore, IRR lies between 10% and 12%. Using interpolation method PV at a rate of 10% =458,654.6 PV required =$400,000 PV at a rate 12% = $366,889.85 Therefore, IRR = 10% + (12% - 10%) x Appendix 3 Computing Internal Rate of Return for DUE company Let 1st choice 10% We choose a higher rate of 14% Therefore, IRR lies between 10% and 16%. Using interpolation method PV at a rate of 10% = $458,654.6 PV required = $400,000 PV at a rate 16% = $366,889.85 Therefore, IRR = 10% + (16% - 10%) x Appendix 4 The cost per share is $1.69, $1.14, and $1.71 for DUET, SKIDA, and TEL respectively. For years, Where in number of years 1. DUE Substituting in the formula for, we get $238,000, $476000, $714,000, and $952,000 for 5, 10, 15, and 20 years respectively. 2. SKIDA Substituting in the formula for, we get $228000, $456000, $684000, and $912000 for 5, 10, 15, and 20 years respectively. 3. TEL Substituting in the formula for, we get $212000, $424000, $636000, and $848000 for 5, 10, 15, and 20 years respectively. References Andrew, A., Philip, B., David, B., & Della, F. (2007). Investment Mathematics. West Sussex P019 85Q: England. David, B., Abel, D., & Zeikel, A. (1998). Investment Analysis.. Irwin: Boston Fredirick, A., (1983). Principles of Investments. Dow Jones-Irwin: USA. Thompson, G. (1973). Investment Appraisal (Cassettes). Miton Keynes: Open University. Willian, S. F., (1985). Investments. Englewood Cliffs NJ: Prentice-Hall. Read More

However, the weakness associated with term deposit is that one may roll over from a high to a low interest rate. Investment Decision From Table 1, the cash inflows for Common wealth bank are more than those of Suncorp and Heritage bank. Therefore, in making capital investment decisions, we use Internal Rate of Return (IRR) analysis method to arrive at a viable investment. From Appendix 2, the IRR is 11.2%. This value is higher than the rate of return. Therefore, it is advisable to invest $400,000 in Common wealth bank, compounded with the fact that it has higher rates of return across the terms as compared to Heritage and Suncorp banks.

Option 2: Stock Market. A stock market involves buyers and sellers trading company stock for a given price. The word, “stock” simply refers to a supply of money a company has collected from individuals or organizations. If one buys stock, he owns a portion of a company. This portion is a “share.” Individuals who own stocks are "stockholders" or “shareholders". Shareholders anticipate sharing profits. In the stocks, DUET Group (DUE), Spark Infrastructure Group (SKIDA), and Telecom Corporation of New Zealand (TEL) are the top performing companies.

We shall consider investing $400,000.00 in them. The summary of the Dividends Accrued from the above Top Three Performing Companies Investment Duration (Years) 1 5 10 15 20 Accrued Dividends DUET 47,600 238,000 476000 714,000 952,000 SKIDA 45,599.97 227,999.85 455,999.70 683,999.55 911,999.40 TEL 42,399.97 211,999.83 423,999.76 635,999.65 847,999.53 Table 2 Note 2: a. The calculations for arriving at the dividends shown in Table 2 above have assumed a lumpsum investment of $400,000.

00 in the three companies considered. b. All the calculations for Table 2 above are in Appendix 4 c. The dividend values in the Table 2 above are in $. Investment Decision From Table 2, DUE Company has higher dividends than SKIDA, and TEL. In making an investment decision, we should further consider the Internal Rate of Return (IRR). From Appendix 3, the IRR for DUE is 15.76%. Since this IRR is higher than dividend yield of 11.9%, investment in this company is viable. Therefore, if the stocks would be the option to take, then DUE would be the most preferred company for which to buy shares.

Stock market has strengths associated with it. For example, investors have the ability to diversify into virtually any industry. They also enjoy tax benefits, the advantage of appreciation of shares, and ability to grow quickly in terms of finances. Assumptions made in the calculations 1. Market volatility The calculations have assumed there is no volatility in the financial market. However, in any investment, one expects higher chances in financial volatility to be associated with higher risks as in the case of stocks.

Therefore, investors who do not like fluctuations in value will tend towards investments which have low risks but also lower potential returns. 2. Political Stability These calculations have also assumed the impact of politics on the stock markets. For prosperity in any economy, fruitful policies and reform measures should be implemented for a long time. 3. Values, Rates, and Costs. The values and rates used are current rates, values, and costs. It is an assumption that they reflect what the future stock market will be like.

However, this will mainly be determined by the market forces affecting each company. The weakness of shares in investments is that they have higher risks and that it is difficult to predict these risks. Some of the expenses associated with stocks include: capital gains tax, securities transaction tax, and brokerage fee. Investment Options for Short Term and Long Term For short term, it is viable to invest in term deposits since they have low risks as compared to the financial volatility of shares.

However, for long term, stock market is a viable option to invest since it has higher returns than term deposits. Besides, the financial volatility of shares is offset for longer investment durations.

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