Case

3.1 a. PFS needs to know how many units of each of the four bonds to purchase, how much to invest in the money market, and their ending balance in the money market fund each year after paying the pensions. The decisions are how many units of each bond to purchase, as well as the initial investment in 2003 in the money market. The objective is to minimize the overall initial investment necessary in 2003 in order to meet the pension payments through 2012. b. Payment received from Bond 1 (2004) = (10 thousand units) ($1,000 face value) + (10,000 units) ($1,000 face value) (0.04 coupon rate) = $10.4 million Payment received from Bond 1 (2005) = $0 Payment received from Bond 2 (2004) = (10 thousand units) ($1,000 face value) (0.02 coupon) = $0.2 million Payment received from Bond 2 (2005) = (10 thousand units) ($1,000 face value) (0.02 coupon) = $0.2 million Balance in money market fund (2003) = $28 million (initial investment) $8 million (pension payment) = $20 million

Balance in money market fund (2004) = $20 million (starting balance) + $10.4 million (payment from Bond 1) + $0.2 million (payment from Bond 2) $12 million (pension payment) + $1 million (money market interest) = $19.6 million Balance in money market fund (2005) = $19.6 million (starting balance) + $0.2 million (payment from Bond 2) $13 million (pension payment) + $0.98 million (money market interest) = $7.78 million c. PFS will need to track the flow of cash from bond investments, the initial investment, the required pension payments, interest from the money market, and the money market balance. The decisions are the number of units to purchase of each bond. Data for the problem include the yearly cash flows from the bonds (per unit purchased), the money market rate, and the minimum required balance in the money market fund at the end of each year. A sketch of a spreadsheet model might appear as follows.

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Money Market Rate Minimum Required Balance Bond Cash Flows (per unit) Bond 1 Bond 2 Bond 3 Bond 4 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Units Purchased Bond Flow Initial Investment Required Pension Flow Money Market Interest Money Market Balance >= >= >= >= >= >= >= >= >= >= 0 0 0 0 0 0 0 0 0 0

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d. The bond cash flows (per unit) are calculated in B7:E9. For example, one unit of Bond 1 costs $0.98 in 2003, and returns the face value ($1) plus the coupon rate ($0.04) in 2004. The total cash flow from bonds is then calculated in column F. The Initial Investment (G7) is both a decision variable and the target cell. It includes all money invested on January 1, 2003 (including enough to pay for the bonds and pension payment in 2003, as well as any initial investment in the money market). If just years 2003 through 2005 are considered, then 23.44 thousand units of Bond 1 should be purchased at a cost of $22.97 million, along with an initial $8 million investment in the money market fund on January 1, 2003.
A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 B C D E F G H I J K L

Money Market Rate Minimum Required Balance Required Pension Flow -8 -12 -13

5% 0 Money Market Interest 0.00 0.62 Money Market Balance 0.00 12.38 0.00

2003 2004 2005 Units Purchased (thousands) Cost of Bonds

Bond Cash Flows (per unit) Bond 1 Bond 2 Bond 3 Bond 4 -0.98 -0.92 -0.75 -0.80 1.04 0.02 0.03 0.02 0.03 23.44 0.98 0 0.92 0 0.75 0 0.8

Bond Flow -22.97 24.38 0.00

Initial Investment 30.97

>= 0 >= 0 >= 0

all cash figures in $millions

I F 5 6 7 8 9

Bond Flow =SUMPRODUCT(B7:E7,UnitsPurchased) =SUMPRODUCT(B8:E8,UnitsPurchased) =SUMPRODUCT(B9:E9,UnitsPurchased)

4 5 6 7 8 9

Money Market Interest =MoneyMarketRate*J7 =MoneyMarketRate*J8

Money Market Balance =SUM(F7:I7) =J7+SUM(F8:I8) =J8+SUM(F9:I9)

Range Name BondFlow InitialInvestment MinimumBalance MinimumRequiredBalance MoneyMarketBalance MoneyMarketInterest MoneyMarketRate PensionFlow UnitsPurchased

Cells F7:F9 G7 L7:L9 I2 J7:J9 I7:I9 I1 H7:H9 B11:E11

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e. Expanded to consider all years through 2012, the spreadsheet is as shown below. PFS should purchase 44.27 thousand units of Bond 1, 51.36 thousand units of Bond 3, and 43.55 thousand units of Bond 4 (at a cost of $116.74 million), and invest an additional $8 million in the money market on January 1, 2003.
A 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 B C D E F G H I J K L

Money Market Rate Minimum Required Balance Bond Cash Flows (per unit) Bond 1 Bond 2 Bond 3 -0.98 -0.92 -0.75 1.04 0.02 0.02 1.02 1.00 Bond Initial Flow Investment -116.74 124.74 47.34 1.31 1.31 1.31 52.67 1.31 1.31 44.86 0.00 Required Pension Flow -8 -12 -13 -14 -16 -17 -20 -21 -22 -24

5% 0 Money Market Interest 0.00 1.77 1.27 0.70 0.00 1.78 0.94 0.00 1.14 Money Market Balance 0.00 35.34 25.42 13.99 0.00 35.67 18.76 0.00 22.86 0.00

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Units Purchased (thousands)

Bond 4 -0.80 0.03 0.03 0.03 0.03 0.03 0.03 0.03 1.03 43.55

>= >= >= >= >= >= >= >= >= >=

0 0 0 0 0 0 0 0 0 0

44.27

51.36

all cash figures in $millions

F 5 6 7 8 9 10 11 12 13 14 15 16

Bond Flow =SUMPRODUCT(B7:E7,UnitsPurchased) =SUMPRODUCT(B8:E8,UnitsPurchased) =SUMPRODUCT(B9:E9,UnitsPurchased) =SUMPRODUCT(B10:E10,UnitsPurchased) =SUMPRODUCT(B11:E11,UnitsPurchased) =SUMPRODUCT(B12:E12,UnitsPurchased) =SUMPRODUCT(B13:E13,UnitsPurchased) =SUMPRODUCT(B14:E14,UnitsPurchased) =SUMPRODUCT(B15:E15,UnitsPurchased) =SUMPRODUCT(B16:E16,UnitsPurchased)

4 5 6 7 8 9 10 11 12 13 14 15 16

Money Market Interest =MoneyMarketRate*J7 =MoneyMarketRate*J8 =MoneyMarketRate*J9 =MoneyMarketRate*J10 =MoneyMarketRate*J11 =MoneyMarketRate*J12 =MoneyMarketRate*J13 =MoneyMarketRate*J14 =MoneyMarketRate*J15

Money Market Balance =SUM(F7:I7) =J7+SUM(F8:I8) =J8+SUM(F9:I9) =J9+SUM(F10:I10) =J10+SUM(F11:I11) =J11+SUM(F12:I12) =J12+SUM(F13:I13) =J13+SUM(F14:I14) =J14+SUM(F15:I15) =J15+SUM(F16:I16)

Range Name BondFlow InitialInvestment MinimumBalance MinimumRequiredBalance MoneyMarketBalance MoneyMarketInterest MoneyMarketRate PensionFlow UnitsPurchased

Cells F7:F16 G7 L7:L16 I2 J7:J16 I7:I16 I1 H7:H16 B18:E18

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