Suggest if the company need to set aside the lump sum of money that will collect interest or company should purchase annuities. Support your suggestion with argument.
I'm having trouble coming up with a "common" circumstance example of why a firm would purchase an annuity. Annuities generally lose their liquidity. The most common reason why a firm would hold a pile of cash is to have cash reserves -- to pay for unexpected events.
To determine whether a company should set aside a lump sum of money that will collect interest or purchase annuities, there are a few considerations you should take into account.
1. Purpose: Consider the intended purpose of the funds. If the company needs the money for a specific future expense, such as funding a project or making large purchases, setting aside a lump sum may be more suitable. On the other hand, if the company wants to secure a consistent income stream over a specified period, purchasing annuities could be more beneficial.
2. Risk tolerance: Evaluate the company's risk tolerance. If the company is risk-averse and prefers a more stable and predictable return on investment, annuities can provide a secure fixed income. However, if the company is willing to take on investment risk and potentially earn higher returns, setting aside a lump sum that collects interest may be more appropriate.
3. Market conditions: Consider the prevailing interest rates. If interest rates are low, setting aside a lump sum may generate minimal returns. In such cases, annuities may offer better interest rates, particularly fixed annuities that guarantee a predetermined payout. Conversely, if interest rates are high, setting aside a lump sum could provide a more attractive return, especially through investment vehicles like bonds or money market accounts.
4. Flexibility and liquidity: Assess the need for flexibility and liquidity. Annuities typically provide a locked-in income stream, limiting immediate access to the funds. If the company anticipates needing the funds for unexpected expenses or unforeseen opportunities, keeping the money in a separate account that collects interest may be more advantageous. A lump sum provides greater liquidity and allows for more flexibility in utilizing the funds as needed.
Ultimately, the decision between setting aside a lump sum or purchasing annuities depends on the specific circumstances and objectives of the company. Careful analysis of the purpose, risk tolerance, market conditions, and need for flexibility will help determine the most suitable option.