6 Chapter 10 Case Study
How Much Interest Is Really Earned?
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 tax-sheltered 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 GICs dollar for dollar. For example, if Sharon’s out-of-pocket investment consists of $2,000 into a GIC, she in fact invests $4,000 into the GIC—$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.
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%.
- Sharon’s out-of-pocket investment history is as follows, by investment type:
| Contribution Date | Amount | Frequency | Interest Rates |
|---|---|---|---|
| December 1, 2006 | $1,000 | Annual on December 1 | 3%, 3.25%, 1.85%, and 0.4002% |
| February 1, 2007 | $1,000 | One-time lump sum | 2.95%, 3%, 3.05%, and 1.003% |
| March 1, 2007 | $1,000 | Annual on March 1 | 3.1%, 2.5%, 1%, and 0.4004% |
| December 1, 2007 | $1,000 | One-time lump sum | 3.3%, 3.4%, and 3.5308% |
| February 1, 2009 | $1,000 | One-time lump sum | 1.75% and 1.9117% |
| December 1, 2009 | $1,000 | One-time lump sum | 1.75% and 1.9117% |
| Contribution Date | Amount | Frequency | Interest Rates |
|---|---|---|---|
| September 1, 2006 | $5,000 | One-time lump sum | 2%, 2.4%, 3%, 4.5%, and 7% |
| Purchase Date | Face Value | Term | Market Yield |
|---|---|---|---|
| December 1, 2006 | $20,000 | 20-year | 7.053% |
| June 1, 2007 | $25,000 | 25-year | 6.5425% |
| December 1, 2008 | $15,000 | 25-year | 5.9067% |
Important Information
- Assume that inflation rates are constant throughout any given year.
Your Tasks
- If Sharon wanted and was able to cash in all of her investments (with no penalty on any early redemptions), calculate the maturity value of all of her investments on June 1, 2010. Calculate the total interest earned across all investments.
- Using the inflation rates, calculate the equivalent value of all her money placed into investments on June 1, 2010.
- 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.
