Linear programming models are used by many Wall Street firms to select a desirable bond portfolio. The following is a simplified version of such a model. Solodrex is considering investing in four bonds; $1,000,000 is available for investment. The expected annual return, the worst-case annual return on each bond, and the “duration” of each bond are given in Table 15. The duration of a bond is a measure of the bond’s sensitivity to interest rales. Solodrex wants to maximize the expected return from its bond investments, subject to three constraints.
Constraint 1 The worst-case return of the bond portfolio must be at least 8%.
Constraint 2 The average duration of the portfolio must be at most 6. For example, a portfolio that invested $600,000 in bond 1 and $400.000 in bond 4 would have an average duration of
Constraint 3 Because of diversification requirements, at most 40% of the total amount invested can be invested in a single bond.
Formulate an LP that will enable Solodrex to maximize the expected return on its investment.
table 15
Bond | Expected Return (%) | Worst-Case Return (%) | Duration |
1 | 13 | 6% | 3 |
2 | 8 | 8% | 4 |
3 | 12 | 10% | 7 |
4 | 14 | 9% | 9 |
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