Question

Decision 2: Financial - Assets Investment

Richelieu Specialty Paints has been quite successful and has $1,500,000 cash to be invested. Amanda and her management team have developed four potential investments in addition to leaving the cash in a low interest deposit. The four new opportunities are:

1. Purchase some shares of a major supplier (25% risk of total loss, 13% potential return)

2. Invest in the research and development of a new product (50% risk of total loss, 60% potential return)

3. Buy a selection of corporate bonds (10% risk of total loss, 6% potential return)

4. Buy a selection of government bonds (1% risk of total loss, 3% potential return)

Leaving the money in a low interest deposit is virtually riskless and has a 0.5% potential return. Richelieu’s father had provided Amanda with some guidelines for investment, aimed at diversification and risk management. These are:

1. Invest a maximum of 40% of the total cash in any one of the four new opportunities to ensure some risk control.

2. Invest at least $100,000 in each of the four new opportunities to ensure some diversity.

3. Limit the total potential loss, on average, to $300,000, based on the risk factors indicated.

4. Ensure the highest return possible.

Recommend the appropriate mix of the four investments and note how much money, if any, should be left in the low interest deposit. Also, how would this mix change, and what would happen to potential return, if Amanda decided to take a more conservative approach and limit the total potential loss to $150,000.

Answer 1

Amount	1500000
(A)
		Risk	return	Weight	Return	Risk
1	shares	25%	13%	7%	13000	25000
2	r&d	50%	60%	35%	310800	259000
3	corp. bond	10%	6%	7%	6000	10000
4	govt. bond	1%	3%	40%	18000	6000
5	Low interest deposit	0%	0.50%	12%	910	0
				100%	348710	300000
	Use solver function in excel to maximise total returns with following constraints
1)	Sum of all weights is equal to 100%
2)	Each of weight for four categories are less than equal to 40%
3)	Invest atleast 100000 or 6.67% of total amount in each of four categories
4)	Maximum loss allowed 300000
5)	Ensure highest return
Appropriate mix for each of four category and low interest deposit:
	Weight	Amount
shares	7%	100000.00
r&d	35%	518000.00
corp. bond	7%	100000.00
govt. bond	40%	600000.00
Low interest deposit	12%	182000.00
Total	100%	1500000.00
182000 should be left in low interest deposit to attain the objectives

(B)	Conservative approach by limiting maximum loss to 150000
		Risk	return	Weight	Return	Risk
1	shares	25%	13%	7%	13000	25000
2	r&d	50%	60%	15%	130800	109000
3	corp. bond	10%	6%	7%	6000	10000
4	govt. bond	1%	3%	40%	18000	6000
5	Low interest deposit	0%	0.50%	32%	2410	0
				100%	170210	150000
	Use solver function in excel to maximise total returns with following constraints
1)	Sum of all weights is equal to 100%
2)	Each of weight for four categories are less than equal to 40%
3)	Invest atleast 100000 or 6.67% of total amount in each of four categories
4)	Maximum loss allowed 150000
5)	Ensure highest return
Appropriate mix for each of four category and low interest deposit:
	Weight	Amount
shares	7%	100000.00
r&d	15%	218000.00
corp. bond	7%	100000.00
govt. bond	40%	600000.00
Low interest deposit	32%	482000.00
Total	100%	1500000.00
482000 should be left in low interest deposit to attain the objectives