ACST152 2015 Week 9 Leverage

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ACST152 2015 Week 9 Leverage

© All Rights Reserved

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A. Calculating the impact of different risks

Q1. Create a spreadsheet which will allow you to test the effect of the following

events on retirement savings. In each case, find the reduction or increase in

retirement savings compared to the base case.

In some cases you can check your answer by doing a manual calculation, in other

cases you will need to use the spreadsheet. (Later in ACST101 you will learn how to

derive formula for calculating accumulations with changes occurring part-way

through the period, but you dont need to know how to do this for ACST152).

(a) Base Case for MaryAnn : Salary $40,000 in first year increasing at 1% p.a.

on 1 January each year. Contributions of 9.5% of salary per annum at the

end of each year. Tax on contributions of 15% and annual administration

fees equal to $200 p.a. increasing at 1% p.a. Investment returns of 7%

p.a., with investment tax at 10% of investment income and an investment

management fee of 1% p.a. (charged as a deduction from the net

investment returns). The worker starts work at age 20 and works until age

65 (45 years)

(b) Starting from the Base Case: Assume that MaryAnns pay is 15% lower

throughout her life, i.e. her starting salary is only $34,000. What is the

impact on her retirement savings?

(c) Starting from the Base Case: Assume that MaryAnn has three children and

she stays at home to look after them until the youngest is at school. She

makes no contributions for years 10, 11, 12, 13, 14, 15, 16, and 17. When

she returns to work she has the same pay rate as if she had been working

all the time. What is the impact on her retirement savings?

(d) Starting from the Base Case: Assume that during the 20 th year, as a result

of regulatory changes, the tax on investment income increases to 15%.

What is the impact on retirement savings for MaryAnn?

(e) Starting from the Base Case: Maryann has some health problems as a

result of her unhealthy lifestyle. She has to retire early, due to ill health.

Her disability income insurance policy pays her living expenses for the

next five years but she does not make any superannuation contributions

during the period from age 60 to 65 (i.e. missing the last 5 years of

contributions). What is the impact on retirement savings for MaryAnn?

(f) Starting from the Base Case: Due to changes in government regulation,

the investment management fees are reduced from 1% p.a. to 0.5% p.a.

(without having any effect on the investment returns). The fees drop

immediately (starting in the first year). What is the impact on retirement

savings for MaryAnn?

Gross contribution in first year is 9.5% * 40000 = 3800

Net Contribution in first year after contributions tax and admin fee = (1-0.15)*3800200 = 3030

The net contribution is assumed to increase at 1% p.a. each year (note that both

salary and admin fees are increasing at 1% p.a. so the net contribution will also

increase at 1% p.a.)

Gross Investment return = 7%

Net investment return after taxes and investment management fee = 7% *(1-0.10)1% = 5.30%

The accumulated value of the first net contribution is 3030 * 1.053^44

The accumulated value of the second contribution is 3030 * 1.01 * 1.053^43

The accumulated value of the third contribution is 3030*1.01^2 * 1.053^42

And so on.....

The accumulated value of the final payment is 3030 * 1.01^44

Summing the accumulated value of all payments (which form a geometric

progression with constant ratio 1.01/1.053 = 0.95916429) gives...

Total accumulation at the end of 45 years = 3030 * 1.053^44 * (0.95916429^45-1)/

(0.95916429-1)

= 609,600

Excel Solution: See Spreadsheet (tab for Base Case)

Use the same method as before, summing a GP

The net contribution is the first year is (0.095*34000) * (1-0.15) - 200 = 2545.50

(0.95916429^45-1)/(0.95916429-1)

= $512,124

Note that the 15% reduction in salary led to a 16% reduction in benefits.

Excel solution: Starting from the base case spreadsheet, you should be able to

simply change the initial salary to $34,000

It is difficult to do this by manual calculation; it is easier to do this in Excel. You

don't need to know how to do such a difficult question for your test - I might ask you

to deduct just one or two missing contributions in a class test.

If you have to do the calculation without a computer, the easiest way is to deduct

the accumulated value of the missing contributions from the answer in (a).

In this case we assume that the administration fees will still be deducted every year

(even though she is not making any contributions)

Based on the calculations in part (a), the net contribution is the first year as 3230.

This increases at 1% p.a., so the next contribution in the 10th year is 3230*1.01^ 9

= 3230*1.01^9

This is paid at the end of year 10 (at t = 10) and accumulates with interest to t = 45

at a net rate of 5.3% p.a.

Accumulated value of net contribution in year 10 at the end of the 45th year=

3313.87 (1.053^35)

So Accum10 = 3230^1.01^9 * 1.053^35 = 21,532.17

Similarly

Accum11 =3230 * 1.01^10 * 1.053^34

Accum12 = 3230 * 1.01^11 * 1.053^33

and so one

Accum17 = 3230 * 1.01^16 * 1.053^28

This forms a GP with n = 8 terms, first term a = 21,532.17, constant ratio r =

1.01/1.053

So the sum of the accumulated value of the contributions made between year 10

and 17 inclusive is

149,549

So the accumulated contributions will be the answer from part (a), which was

609,600, less 149,549, giving 460,051

Excel solution: Starting from the base case spreadsheet, put 0 in the working

column for the relevant years. This should change the contributions to 0.

Starting from the Base case: Assume that Mark stays at Uni to do a PhD

and does not start work until age 25. His salary when he starts is $45,000.

What is the impact on his superannuation savings?

Starting from the Base Case: Assume that during the 20 th year, as a result

of regulatory changes, the tax on investment income increases to 15%.

What is the impact on retirement savings for MaryAnn?

Note: the question was not very clear on the timing of the change.

If the change occurs at the start of year 20, the answer is

Answer : 566,627 (from spreadsheet) a reduction of 7.0%

If the change occurs at the end of year 20 (so that the new rate applies in

year 21 and after), the answer is 567,832

Answer : 567,832 (from spreadsheet) a reduction of 6.9%

Starting from the Base Case: Maryann has some health problems as a

result of his unhealthy lifestyle. She has to retire early, due to ill health.

Her disability income policy pays her living expenses for the next five

years but she does not make any superannuation contributions for the

five year period from age 60 to 65 (i.e. missing the last 5 years of

contributions). What is the impact on retirement savings for MaryAnn?

Answer: $582,355 (from spreadsheet) a reduction of 4.5%

fees

Starting from the Base Case: Due to changes in government regulation,

the investment management fees are reduced from 1% p.a. to 0.5% p.a.

(without having any effect on the investment returns). The fees drop

immediately (starting in the first year).

Answer: $699,320 (from spreadsheet) an increase of 14.7%

multiple payments, and fixed term annuities

Q1. Present Values

The present value P is the amount which must be invested now, in order to

provide a specified sum R at a specified future time t, assuming that the amount is

invested to earn compound interest at i per annum.

P * (1+i)t = R

Therefore P = R *(1+i)

-t

(a) Payments of $100 at time t = 1, $200 at time t = 2, $300 at time t = 3, at 5%

p.a

(b) Payments of $1800 at time t = 6, $1200 at time t = 8, $500 at time t = 12, at

2% p.a

Solution:

(a) PV = 100 * 1.05^-1 + 200 * 1.05^-2 + 300 * 1.05^-3 = 535.80

Check: if you had $535.80 in the bank account at time 0,

The balance at time 1 (after making the first payment) would be 535.80*1.05-100 =

462.59

The balance at time 2 (after making the second payment) would be 462.59*1.05200 = 285.72

The balance at time 3 (after making the third payment) would be 285.72*1.05-300

= 0.01

This shows that $535.80 would be the amount required in the account at time 0,

which will be sufficient to make the required payments, with nothing left over (apart

from a cent arising from rounding off).

Reasonableness check: the present value of a series of payments should be less

than the sum of the payments (assuming the interest earned on the account is

positive).

In this case $535.80 is less than $600 (i.e. less than 100 + 200 + 300) so this is

reasonable.

(b) PV = 1800 * 1.02 ^ -6 + 1200 * 1.02^-8 + 500 * 1.02 ^ -12 = 3016.78

7

The balance at time 6 (after making the first payment) would be 3016.79*1.02^61800 = 1597.40

The balance at time 8 (after making the second payment) would be

1597.40*1.02^2-1200 = 461.94

The balance at time 12 (after making the third payment) would be 461.94*1.02^4

-500 = 0.02

This shows that $3016.79 would be the amount required in the account at time 0,

which will be sufficient to make the required payments, with nothing left over (apart

from 2 cents arising from rounding off).

Reasonableness check: the present value of a series of payments should be less

than the sum of the payments (assuming the interest earned on the account is

positive) In this case $3016.78 is less than $3500 (i.e. less than 1800 + 1200 +

500) so this is reasonable.

(a) Ann is going to put $P1 in a bank account today. It will earn interest at 5% per

annum compound interest. This will accumulate to $10000 at the end of the year.

What is the amount P1?

(b) Ann is going to put $P2 in a bank account today. It will earn interest at 5% per

annum. This will accumulate to $10000 at the end of the 2 years. What is the

amount P2?

(c) Ann is going to put $P3 in a bank account today. It will earn interest at 5% per

annum. This will accumulate to $10000 at the end of the 3 years. What is the

amount P3?

(d) Ann is going to put $P4 in a bank account today. It will earn interest at 5% per

annum. This will accumulate to $10000 at the end of the 4 years. What is the

amount P4?

(e) What is the total amount Ann should put in the bank now, in order to provide

$10,000 per annum at the end of each year for the next 4 years?

Solution

(a) Present Value for first payment = 10,000/1.05 = $9,523.81

8

(c) Present Value for first payment = 10,000/1.05^3 = $8,638.38

(d) Present Value for first payment = 10,000/1.05^4 = $8,227.02

(e) Total for all four payments = 10,000 / 1.05 + 10,000 / 1.05^2 + 10,000 / 1.05^3

+ 10,000/ 1.05^4

= 35,459.51

Suppose that an account has an initial balance of P at time 0. The account will earn

interest at rate i p.a. Money will be withdrawn from the account at the end of each

year, and the amount withdrawn at time t is denoted

Ct

C2 =100 .

There might also be an

into the account, so it only increases as a result of investment income. Note that

the account balance might become negative if there is not enough money to make

all the repayments.

(a) Use the method of induction to show that the account balance at time n (just

after any payment withdrawn at that time) will be given by

n

nt

t=0

(b) Suppose that P, the money in the account at time 0, is exactly enough to

make all the payments up until time n, with nothing left over. {That is, P is

the present value of the payments.} Set the account balance at time n equal

to 0 and solve for P in order to find an expression for the present value.

{This should verify the statement made in lectures: the present value of a series

of payments is the sum of the present values of each individual payment.}

Solution

Step 1: show that the proposition is true for n = 1

Suppose that the contribution at time 0 is C 0. This will earn interest for one year. At

that time an additional contribution will be made, denoted C 1. So the accumulated

balance at the end of the first year will be

as

C t(1+i)1t

t=0

Step 2: show that if the proposition is true for n = k, then the proposition

is true for n = k+1

10

Let

Bk

Ck

the account).

By assumption,

k

B k = C t(1+i )

kt

t=0

Let

B k+1

C k+1

has been

The balance at time k+1 will be the balance at time k, plus one years interest, plus

the additional contribution made at the end of the year. So...

Now by using our assumption, and substituting for B k,

B k+1=

B k+1=

B k+1=

t=0

C t(1+i)k+1t

t=0

k+1

t=0

C t( 1+ i )k +1t

+Ck +1

Step 3 Combining step 1 and step 2, and applying the Principle of

Mathematical Induction

the proposition is true for n = 1,2,3,....

11

(a) Assuming that there are n equal payments of amount C, payable at the end

of each year from year 1 to n, then the present value of these payments is

given by

n

C(1+ i)t

t =1

Use the formula for the sum of a GP to derive the present value of these

payments. This is the formula for a fixed term annuity with payments payable

in arrears. In actuarial notation the present value of $1 p.a. payable in arrears

for a fixed term of n years is denoted

n

a

(b) Use this formula to calculate that the total amount needed to pay $10,000

per annum at the end of each year for the next four years, assuming interest

is earned at 5% p.a., and verify that this matches the answer to Q2 above

(Anns payments). In actuarial notation this would be

4

10,000 a

(c) Assuming that the payments are increasing over time, so that the payment at

the end of the tth year, denoted Ct, is C*(1+f)^(t-1). Then the present value

of these payments is given by

n

C t(1+i)t

t =1

Use the formula for the sum of a GP to derive the present value of these

payments.

Solution:

(a) If the payments are fixed at C per annum, and the first payment is at time

t=1, then the present value is

The present value of the payments is a geometric progression with

initial term

C(1+i)1

12

constant ratio

(1+i)1

n terms

So using the formula for the sum of a GP gives the present value of the

payments as

C (1+i)1[1( 1+i )n ]

1(1+i)1

Multiple by (1+i)/(1+i) to get

C[1( 1+i )n ]

1+i1

C[1( 1+i ) ]

i

This gives us the standard formula for the present value of a series of

payments of $C payable annually in arrears for n years. In actuarial notation

this is denoted as

n

Ca

(b) We can use this formula to find the PV of $10000 per annum payable annually

in arrears for 4 years at 5% p.a

PV =

1000011.054

0.05

PV = 35,459.51

This matches the answer from question 2.

(c) Assuming that the payments are , so that the payment at the end of the tth

year, denoted Ct, is C*(1+f)^(t-1). Then the present value of these

payments is given by increasing over time fixed at C per annum, and the first

payment is at time t=1, then the present value is

13

n1

(1+i)

C(1+i)1

initial term

constant ratio

( 1+f )(1+i)1

n terms

So using the formula for the sum of a GP gives the present value of the

payments as

C (1+i)1[1(1+ f )n ( 1+i )n ]

1(1+ f )(1+i)1

Multiple by (1+i)/(1+i) to get

n

C[1(1+ f ) ( 1+i ) ]

(1+ i)(1+f )

C[1(1+ f )n ( 1+i )n ]

if

10000 at the end of the first year,

10000*1.02 in the second year,

10000*1.02^2 in the third year

and so on, for 10 payments

Using an Excel spreadsheet and calculating the present value of each payment at

5% p,a

14

1

2

3

4

5

6

7

8

9

10

$

$

$

$

$

$

$

$

$

$

10,000.00

10,200.00

10,404.00

10,612.08

10,824.32

11,040.81

11,261.62

11,486.86

11,716.59

11,950.93

$

$

$

$

$

$

$

$

$

$

sum

9,523.81

9,251.70

8,987.37

8,730.58

8,481.14

8,238.82

8,003.43

7,774.76

7,552.62

7,336.83

83,881.06

Using the formula with i = 0.05 and f = 0.02 and C =10000 and n = 10 gives:

PV = 10000 * [1 - (1.02/1.05)^10] / (0.05-0.02) = 83,881.06

15

Assume that there are n equal payments of amount $ 1, payable at the start of

each year (i.e. at times t = 0,1,2,...n-1). This is called a fixed term annuity payable

in advance. In actuarial notation, the present value of $1 p.a. payable in advance

for a fixed term of n years is denoted

n

a , where the double-dots indicate

payment in advance.

Show that

n=

( 1+i ) a

a

0,1,2,3...n-1.

(a) Using the result derived in a previous question, the present value of these

payments is

n1

1(1+i)t

t=0

These payments are in a geometric progression with first term 1 and constant

ratio (1+i)-1, with n terms, so the present value of all payments combined is

n

a

1[1( 1+i )n ]

1(1+i )1

n

a

n

a

(1+i)[1( 1+i ) ]

1+i1

(1+i)[1( 1+i )n ]

i

n

a

n

(1+i)a

16

advance is (1+I) multiplied by the present value of the same set of payments

made annually in arrears

17

(a) Joseph intends to retire on his 65th birthday. He expects to live for exactly 20

years and would like to have an income of $40,000 per annum, payable at the end

of each year for 20 years. How much does he need to have in his superannuation

account at age 65, in order to meet this objective? Assume that he will be able to

earn 6% p.a.

(b) Now allow for inflation in the cost of living at 2% pa. Joseph intends to retire on

his 65th birthday. He expects to live for exactly 20 years and would like to have

withdraw of $40,000 per annum at the end of the first year, $40,000 * 1.02 at the

end of the second year, $40,000 * 1.02^ 2 at the end of the third year, and so on.

How much does he need to have in his superannuation account at age 65, in order

to meet this objective? Assume that he will be able to earn 6% p.a.

(c) Maryann intends to retire on her 60th birthday. She expects to live for exactly 30

years and would like to have an income of $50,000 per annum, payable at the

start of each year for 30 years. How much does she need to have in her

superannuation account at age 60, in order to meet this objective? Assume that she

will be able to earn 5% p.a.

(d) Now allow for inflation in the cost of living at 1% p.a. Maryann intends to retire

on her 60th birthday. She expects to live for exactly 30 years and would like to

withdraw $50,000 at the end of the first year, $50,000 * 1.01 at the end of the

second year, $50,000 * 1.01^2 at the end of the third year, and so on. How much

does she need to have in her superannuation account at age 60, in order to meet

this objective? Assume that she will be able to earn 5% p.a.

Solution

(a) Present value of payments of $40,000 p.a. payable in arrears for 20 years at 6%

=

40000 * [1-1.06^-20]/0.06 = 458,796.85

(b) Present value of payments of $40,000 in the first year, increasing at 2%p.a, in

arrears for 20 years.

PV of first payment = 40000 / 1.06

PV of second payment = 40000 * 1.02 / 1.06^2

PV of third payment = 40000 * 1.02^2 / 1.06^3

and so on.

This is a GP where the first term is 40000/1.06 and the constant ratio is

1.02/1.06 and there are 20 terms

18

Using the sum of a GP formula, the present value of all the payments

combined

PV of all payments = 40000 / 1.06 * [(1.02/1.06)^20 - 1] / [(1.02/1.06) - 1] =

536,674.58

Reasonableness check - since the payments in (b) are higher than the payments in

(a),

the answer to (b) should be higher than the answer to (a)

(c) Present value of payments of $50,000 p.a. payable in advance for 30 years at

5%

= 50,000 * [1-1.05^-30]/0.05 * 1.05 = 807,053.68

(d) Present value of payments of $50,000 in the first year, increasing at 1%p.a, in

arrears for 30 years, at interest rate 5% p.a.

PV of first payment = 50000 / 1.05

PV of second payment = 50000 * 1.01 / 1.05^2

PV of third payment = 50000 * 1.01^2 / 1.05^3

and so on.

This is a GP where the first term is 50000/1.05 and the constant ratio is

1.01/1.05 and there are 30 terms

Using the sum of a GP formula, the present value of all the payments

combined

PV of all payments = 50000 / 1.05 * [(1.01/1.05)^30 - 1] / [(1.01/1.05) - 1] =

860,172.70

19

calculate the present value of a series of regular payments, so there is a standard

Ran

notation for this.

at i represents the present value of payments of R

per annum at the end of each year for n years, at interest rate i per annum.

Ran

(a) Use a general reasoning argument to explain why

should always be less than R * n.

at i (i > 0)

(b) For a given set of non-negative payments: the higher the interest rate, the lower

the present value. Verify this mathematically.

Solution

(a) If the account did not earn any interest, then we would need an amount of

R*n to make all the payments.

If the account does earn interest, then the investment income will cover some

part of each payment.

So we dont need to have the entire sum R*n in the account, we can start with a

lower amunt

Ran

Hence if the interest rate is positive, then

always be less than R * n.

at i (i > 0) should

(b) The present value is a function of the interest rate. We can show that the

function is monotonic decreasing, i.e. the first derivative with respect to i is

negative , when the interest rate is positive.

n

P (i )= Ct (1+ i)

t =0

P' (i )= (t )C t (1+i )

t1

t =0

If the values of t, Ct, and i are all positive, then the first derivative must be

negative. Hence the higher the interest rate, the lower the present value.

20

21

Q8. Andrew has $300,000 as a lump sum at age 65. He intends to withdraw $R per

annum at the end of each year for the next 30 years, and then die at time t = 30.

He doesnt intend to have any money left over after he dies.

(a) How much can he withdraw every year, assuming that the rate of interest

earned is 5% p.a.?

(b) Suppose that Andrew withdraws $25,000 p.a in arrears. How long will it be

until he runs out of money? [Find the first year in which his balance at the

end of the year is negative]

(c) Suppose that Andrew withdraws $14,000 p.a. in arrears. How long will it be

until he runs out of money?

(d) Suppose that due to a breakthrough in biomedical technology, Andrew will

live forever. He will withdraw $Y at the end of every year, forever [Note that

this is called a perpetuity]. What is the value of Y which will make the

present value of the payments equal to $300,000? Verify your answer by

general reasoning.

Solution

(a) Solve for the value of R such that

300,000=

30

300,000=R a

R11.0530

0.05

R = 19,515.43

300,000<

2500011.05

0.05

n >300,000

25000 a

120.05< 11.05

1.05n <10.60

22

n<

log ( 0.40)

log ( 1.05)

This shows that Andrew will be able to withdraw $25,000 p.a. for 18 years,

but in the 19th year the amount in the account will be less than $25,000.

He will be able to withdraw a reduced amount at that time.

Practice: Try to do this question with the EXCEL solver just to make sure

you know how to use the Solver.

(c) Trick question ! Andrew will never run out of money. The account of

$300,000 earns interest at 5% p.a., which means that the interest in the

first year is $15,000. Andrew is only withdrawing $14,000. At the end of

the year, the balance will increase to $301,000. The balance will keep

increasing each year, so Andrew will never run out of money. When he

dies, his heirs will receive an inheritance of more than $300,000.

Note that this system will only work if the interest rate is always 5% p.a. If

the interest rate fluctuates randomly, and might have low values, then

there is a chance that Andrew will run out of money.

(d)

The account earns $15,000 per annum. Andrew can withdraw this

amount every year,

and he

will never run out of money.

A sum of P invested at rate i per annum will provide a perpetuity of C =

P * i per annum.

You can deduce this mathematically by finding the present value of

payments of C per annum payable forever.

PV = C* (1+i) ^-1 + C * (1+i) ^ -2 + C*(1+i)^-3+......

The sum to infinity of a geometric progression with first term a and

constant ratio r is a/(1-r), as long as the absolute value of r is less than 1.

In this case a = C * (1+i)^-1 and r = (1+i)^-1

Verify that the present value of an infinite number of payments of C

per annum is given

by

PV = C/i

23

is C/i

Alternatively a sum of P invested at i per annum will fund a

perpetuity of C = iP

24

Q9. Bob has $300,000 as a lump sum at age 65. Bob knows that the cost of living

will increase over time, and he estimates that the inflation rate will be 2% per

annum. He intends to withdraw $R at the end of the first year, $R * 1.02 at the end

of the second year, $R*1.02^2 at the end of the third year, and so on for the next

30 years. He expects to die before the 31st payment falls due. He doesnt intend to

have any money left over after he dies.

(a) How much can he withdraw every year, assuming that the rate of interest

earned is 5% p.a.?

(b) Suppose that due to a breakthrough in biomedical technology, Bob will live

forever. He will withdraw $Y * (1.02)^(t-1) at the end of the tth year, forever

[an increasing perpetuity]. What is the value of Y which will make the present

value of the payments equal to $300,000? Verify your answer by general

reasoning.

(c) Suppose that inflation is 6% p.a. Revise your answer to part (b) allowing for

payments that increase at 6% p.a.

Solution:

(a) Use the formula we derived previously, for the present value of an

increasing annuity, with f = 2% and i = 5% and n = 30

n

R[1(1+ f ) ( 1+i ) ]

if

Set this present value equal to 300,000 and solve for R. R = 15,493.42

(the cash flows are shown on the next page)

(b) We want the balance to keep increasing in line with inflation. This ensures

that the real value of our wealth remains constant. Hence we want to find the value

of the withdrawal which satisfies

Balance at start of year * (1+i) - withdrawal = Balance at end of year

Balance at end of year = Balance at start of year * (1+f)

In this case, for the first year:

300,000 * 1.05 - Y = 300,000 * 1.02

Y = 300,000 * (1.05-1.02)

Y = 9000

(the cash flows are shown on the next page)

25

(c) There is no sensible answer for part (c). If inflation is making prices increase at

6% p.a, and your investment return is only 5% p.a, then your standard of living

must decline.

year

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

balance

start year

300,000.00

299,506.58

298,678.62

297,493.20

295,926.12

293,951.85

291,543.45

288,672.52

285,309.08

281,421.52

276,976.53

271,938.96

266,271.79

259,935.98

252,890.38

245,091.67

236,494.15

227,049.71

216,707.67

205,414.63

193,114.38

179,747.69

165,252.22

149,562.32

132,608.87

114,319.12

94,616.48

73,420.34

50,645.85

26,203.72

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

interest

earned

15,000.00

14,975.33

14,933.93

14,874.66

14,796.31

14,697.59

14,577.17

14,433.63

14,265.45

14,071.08

13,848.83

13,596.95

13,313.59

12,996.80

12,644.52

12,254.58

11,824.71

11,352.49

10,835.38

10,270.73

9,655.72

8,987.38

8,262.61

7,478.12

6,630.44

5,715.96

4,730.82

3,671.02

2,532.29

1,310.19

26

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

payment

end year

15,493.42

15,803.29

16,119.35

16,441.74

16,770.58

17,105.99

17,448.11

17,797.07

18,153.01

18,516.07

18,886.39

19,264.12

19,649.40

20,042.39

20,443.24

20,852.10

21,269.14

21,694.53

22,128.42

22,570.99

23,022.41

23,482.85

23,952.51

24,431.56

24,920.19

25,418.60

25,926.97

26,445.51

26,974.42

27,513.91

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

balance

end year

299,506.58

298,678.62

297,493.20

295,926.12

293,951.85

291,543.45

288,672.52

285,309.08

281,421.52

276,976.53

271,938.96

266,271.79

259,935.98

252,890.38

245,091.67

236,494.15

227,049.71

216,707.67

205,414.63

193,114.38

179,747.69

165,252.22

149,562.32

132,608.87

114,319.12

94,616.48

73,420.34

50,645.85

26,203.72

0.00

Note that the balance must increase by 2% p.a. in order to fund payment which

increase at 2% p.a.

year

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

balance

start year

300,000.00

306,000.00

312,120.00

318,362.40

324,729.65

331,224.24

337,848.73

344,605.70

351,497.81

358,527.77

365,698.33

373,012.29

380,472.54

388,081.99

395,843.63

403,760.50

411,835.71

420,072.43

428,473.87

437,043.35

445,784.22

454,699.90

463,793.90

473,069.78

482,531.17

492,181.80

502,025.43

512,065.94

522,307.26

532,753.41

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

interest

earned

15,000.00

15,300.00

15,606.00

15,918.12

16,236.48

16,561.21

16,892.44

17,230.29

17,574.89

17,926.39

18,284.92

18,650.61

19,023.63

19,404.10

19,792.18

20,188.03

20,591.79

21,003.62

21,423.69

21,852.17

22,289.21

22,735.00

23,189.70

23,653.49

24,126.56

24,609.09

25,101.27

25,603.30

26,115.36

26,637.67

27

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

payment

end year

9,000.00

9,180.00

9,363.60

9,550.87

9,741.89

9,936.73

10,135.46

10,338.17

10,544.93

10,755.83

10,970.95

11,190.37

11,414.18

11,642.46

11,875.31

12,112.82

12,355.07

12,602.17

12,854.22

13,111.30

13,373.53

13,641.00

13,913.82

14,192.09

14,475.94

14,765.45

15,060.76

15,361.98

15,669.22

15,982.60

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

$

balance

end year

306,000.00

312,120.00

318,362.40

324,729.65

331,224.24

337,848.73

344,605.70

351,497.81

358,527.77

365,698.33

373,012.29

380,472.54

388,081.99

395,843.63

403,760.50

411,835.71

420,072.43

428,473.87

437,043.35

445,784.22

454,699.90

463,793.90

473,069.78

482,531.17

492,181.80

502,025.43

512,065.94

522,307.26

532,753.41

543,408.48

Discussion Question

There have been many studies which have looked at the issue of retirement

adequacy, i.e. whether the old age pension plus 9.5% compulsory superannuation

savings will be sufficient to provide an adequate standard of living in retirement.

Some people argue that the 9.5% contribution rate is not enough and the

compulsory rate should be increased to 12%.

Others would argue that the compulsory superannuation contributions should just

provide a modest standard of living and then people should be left to make their

own decisions about making additional voluntary contributions., if they want a

better standard of living in retirement.

(a) Suppose that you were just about to start a new job. Your boss asks if you

would like to make voluntary contributions into your super fund, on top of the

compulsory contributions. These voluntary contributions would be deducted

from your pay and sent to the superannuation fund. What would you say?

Give some reasons why people would decide AGAINST paying additional

contributions when they are under age 30.

(b) Government policy-makers are concerned that many people fail to make

voluntary contributions (until shortly before retirement) and hence will have

inadequate retirement savings. As mentioned in lectures, the Financial

Services Council has issued press releases about the Retirement Savings Gap

(a copy of the press release is available on iLearn). There have been several

suggestions for persuading people to make additional contributions.

a. The government could provide better financial incentives for savers.

Look up the Australian co-contribution rules (at

http://www.rest.com.au/co-cont) and see if that influences your

decision.

b. Behavioural finance researchers have attempted to devise methods

which will lead to increased superannuation savings. One well-known

experiment is the Save More Tomorrow (SMarT) program. Watch

http://befi.allianzgi.com/en/Topics/Pages/save-more-tomorrow.aspx.

c. Behavioural finance studies have led to the development of the

concept of soft compulsion. Find out about this idea. Do you think

this sort of system should be introduced in Australia? Some Australian

organisations such as the Association of Superannuation Funds of

Australia (ASFA) have advocated soft compulsion systems.

28

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