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10.CS: Case Study - How Much Interest Is Really Earned?

  • Page ID
    28568
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    The Situation

    Sharon works for Lightning Wholesale, which strongly encourages its employees to save up for retirement. After learning on June 1, 2006, that the company matches dollar for dollar any employee investments into their RRSPs, she has been pursuing her RRSP actively.

    Sharon soon figured out one important and often misunderstood fact about RRSPs. Though many people think of an RRSP as a financial tool, like a savings account, into which money is invested, she realized that an RRSP is actually a taxsheltered environment. Within the RRSP you can invest your money into various financial tools to save your retirement income, and any interest or capital gains that are earned on these investments are not taxable. This is in contrast to investments held outside an RRSP environment; for the latter, all earnings are subject to annual income taxes. The financial tools available to an RRSP could include GICs, mutual funds, bonds, securities, trusts, gold bullion, and stocks, just to name a few. Sharon’s portfolio happens to include CSBs, GICs, and strip bonds.

    She is interested in learning how much money she has saved up by June 1, 2010, and how much of that money is actually real, inflation-adjusted growth in her savings. In other words, she wants to account for inflation and get an understanding of how much real interest beyond cost of living adjustments she has earned in her RRSP.

    The Data

    • Lightning Wholesale matches any employee investment in CSBs, CPBs, and GICs dollar for dollar. For example, if Sharon's out-of-pocket investment consists of $2,000 into a savings bond, she in fact invests $4,000 into the savings bond—$2,000 from her own pocket and $2,000 from Lightning Wholesale.
    • Lightning Wholesale matches any employee investment in strip bonds by providing enough money to purchase a second identical strip bond.
    • Sharon's out-of-pocket investment history is as follows:
      • Each March 1 and December 1 since June 1 of 2006 she has had $1,000 to invest in C-bond CSBs.
      • She has invested $1,000 into each of Series P55, P59, P67, and P71 C-bond CPBs.
      • She placed $5,000 into a five-year escalator GIC on September 1, 2006, paying quarterly compounded rates each year of 2%, 2.4%, 3%, 4.5%, and 7%.
      • She purchased three strip bonds: - On December 1, 2006, she purchased a 20-year $20,000 face value strip bond with a market yield of 7.053%. - On June 1, 2007, she purchased a 25-year $25,000 face value strip bond with a market yield of 6.5425%. - On December 1, 2008, she purchased a 25-year $15,000 face value strip bond with a market yield of 5.9067%.
    • On June 1, 2010, the market yield of strip bonds with 16½-year maturities was 6.5425%, 22-year maturities was 4.9855%, and 23½-year maturities was 4.8821%.
    • Annual June to June inflation rates starting with June 2006 to June 2007 have been 2.19%, 3.13%, −0.26%, and 0.96%.

    Important Information

    • Although CPBs can only be cashed during the anniversary month, calculate the accrued interest to June 1, 2010, for all CPBs using simple interest for any partial years.
    • Assume that inflation rates are constant throughout any given year.
    • Information about CSBs and CPBs is found in the savings and premium bond tables earlier in the chapter.

    Your Tasks

    1. If Sharon wanted and was able to cash in all of her investments, calculate the maturity value of all of her investments on June 1, 2010. Calculate the total interest earned across all investments.
    2. Using the inflation rates, calculate the equivalent value of all her money placed into investments on June 1, 2010.
    3. Calculate the difference between her actual maturity value and her inflation-adjusted principal. This is the real amount of interest that she has gained over the years.

    Contributors and Attributions


    10.CS: Case Study - How Much Interest Is Really Earned? is shared under a not declared license and was authored, remixed, and/or curated by LibreTexts.

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