An institutional investor will have to pay off a maturing bond issue in 3 years. The institution has 10,000 bonds outstanding, each with a $1,000 par value. The institutional money manager is reevaluating the fund's total portfolio of $100 million at this time. She is bullish on stocks and wants to put the most she can into the stock market, but she cannot risk being unable to pay off the bonds. Three-year zero-coupon bonds are available paying 6% interest. What percentage of the total $100 million portfolio can she put in stocks and still ensure meeting the bond payments?

Question

Quizplus · Accepted Answer

(10,000)(1,000) = $10,000,000 due in 3 years
$10,000,000/1.063 = $8,396,193 = present value of due amount
Calculator entries are n = 3, I/Y = 6, PMT = 0, FV = −10,000,000, CPT PV → 8,396,192.83.
She must devote this much of the $100 million portfolio to zero-coupon bonds, so the maximum amount to put in stocks is $100,000,000 − 8,396,192.83 = $91,603,807.17, or $91,603,807.17/$100,000,000, which is approximately 91.6% of the total portfolio value.

An Institutional Investor Will Have to Pay Off a Maturing