Basic interest rate and maximum interest rate, Financial Accounting

Suppose a risk neutral agent has $100,000 today that he wants to save for one year. Compare the following two savings plans.

Bank A offers a standard savings account with 4% p.a.

Bank B offers the following alternative:

There is a basis interest rate of 1% p.a. and 50% participation on the performance of the S&P500. The maximum interest rate is capped at 7% p.a. (E.g. If the S&P increases by 6%, there is a bonus of 3% so that the total return is 4% p.a. If the return of the S&P is 20%, the plan has a return of 7%. Note, if the S&P has a negative return, the interest rate remains at 1% p.a.)

Suppose the S&P has 1000 points at t=0. At t=1 it can have {900, 990, 1000, 1020, 1040, 1100, 1120, 1200, 1260, 1300} points with equal probability.

(a) Draw the payoff of alternative B as a function of the S&P (with the S&P performance on the X-axis, and the return of the plan on the Y-axis.)

(a) The agent maximizes the expected amount at t=1. Which plan is better? How much more can the agent spend in expectation at t=1, if he chooses the better one?

 

Posted Date: 3/29/2013 5:30:18 AM | Location : United States







Related Discussions:- Basic interest rate and maximum interest rate, Assignment Help, Ask Question on Basic interest rate and maximum interest rate, Get Answer, Expert's Help, Basic interest rate and maximum interest rate Discussions

Write discussion on Basic interest rate and maximum interest rate
Your posts are moderated
Related Questions
Closing Entries: Expenses Below is a list of accounts with corresponding ending balances. Account: Account Balance a.Insurance Expense: $1,300 b.Cash: 750 c.Accounts Receivable: 4,

The opening entries 1. Assets of the estate or trust In both cases the various assets of the estate or trust are debited to appropriate accounts and credited to the Estate Ca

Five years ago Ramon Millan quit his job as an associate at a large law firm and opened a burger joint in Malibu. His innovative use of aged blue cheeses and specialty sauces resul


Describe the accounting concept of a business combination. Business Combination: According to International Financial Reporting Standard-3 Business Combinations "A busi

Calculate the NPV and ARR The manager of XYZ Ltd has identified a market for a new product that she estimates can be sold for $12 per unit. Research indicates that the busines

Return on Investment (ROI) - Ratio measure of the profits achieved by a firm by its fundamental operations. An indicator of management's general efficiency andeffectiveness. The si

provide 5% for doubtful debt what is the journal entry

how do you record this transaction? May 18 Issues 30,000 additional shares of $2 common stock for $75 per share. May 25 Issue 8,000 shares of preferred stock for $125 per sha

Equity shareholders, potential and present, seem primarily to the company's record of earnings. They are thus interested in relationships as earnings per share or EPS and dividends