291-028 Valuation and Discounted Cash Flows Valuation and Discounted Cash Flows 291-028 Tables for Problem #3 are extracted from The Wall Street Journal, July 2, 1992 3. After consistently failing to win the lottery for several years, you notice the following article in the Wall Street Journal. Here's your chance to buy a lottery ticket that is a guaranteed winner. But since it will apparently cost a bit over the original $1 ticket price, the winning ticket is considerably out of your price range. The investment company you work for is, however, interested in such opportunities. You decide to research a bit further and gather the interest rate data (on the next page) for the day before the ticket is auctioned. In your "first cut" at the analysis, you decide to ignore taxes. The winner will receive the first of the 16 payments almost immediately, with the rest stretched out over 15 years. TREASURY BONDS, NOTES & BILLS If you can purchase the ticket for $2.0 million, what annual rate of return will you get on your investment? What about if you win the bid at $1.5 million? Given the current (July 1, 1992) prices and yields in the capital markets, what do you think is the approximate "fair market value" of the ticket? If you factored taxes into this situation, how would it change your valuation of the ticket? The Wall Street Journal, June 30, 1992 Pricey, but Perhaps the Only Way To Buy a Certain Lottery Winner Wednesday, July 1, 1992 Representative Over-the-counter quotations based on transactions of $1 million or more. Treasury bond, note and bill quotes are as of mid-afternoon. Colons in bid-and-asked quotes represent 32nds; 101:01 means 101 1/32. Net changes in 32nds. n-Treasury note. Treasury bill quotes in hundredths, quoted on terms of a rate of discount. Days to maturity calculated from settlement date. All vields are to maturity and based on the asked quote. Latest 13-week and 26-week bills are boldfaced. For bonds callable prior to maturity, ylelds are computed to the earliest call date for Issues quoted above par and to the maturity date for Issues below par..-When Issued. Source: Federal Reserve Bank of New York. U.S. Treasury strips as of 3 p.m. Eastern time, also based on transactions of $1 million or more. Colons In bld-and-asked quotes represent 32nds; 101:01 means 101 1/32. Net changes in 32nds. Yields calculated on the asked quota- tion. Cl-stripped coupon Interest. bo-Treasury bond, stripped principal. no-Trea- sury note, stripped principal. For bonds caltable prior to maturity, yields are computed to the earliest call date for Issues quoted above par and to the maturity date for issues below par. Source: Bear, Stearns & Co. via Street Software Technology Inc. GOVT. BONDS & NOTES Maturity ASK Maturity Ask Rate Mo/Yr Bid Asked Cho. Yid. Rate Mo/Yr Bid Asked Cho. Yld. 8/ Nov 970 111:04 111:06 + 5 6.38 109 Jul 92 100:07 10:09 - 10.95 7 Jan 98 106:17 106:19 + 46.44 8 Jul 2n 100:11 100:13 ... 2.01 8 Feb 98 107:20 107:22 + 3 6.47 AV4 Aug 2 98:31 99:15 .... 8.98 T'A Apr 98 106:15 106:17 + 46.50 7/4 Aug 2 100:13 100:15 .... 2.89 7 May 93-98 101:05 101:13 .... 5.31 7 Aug 2n 100:15 100:17 .... 2.93 9 May 98n 111:24 111:26 + 46.54 814 Aug 2n 100:16 100:18 ... 3.02 814 Jul 98 108:07 108:09 3 8.56 8 Aug 22n 100:22 100:24 .... 3.09 91/4 Aug 98 113:04 113:06 + 46.59 81. Sep 2n 101:02 101:04 .... 3.23 7 Oct 98 102:22 102:24 + 46.58 8/4 Sep 2n 101:06 101:08 .... 3.31 312 Nov 98 97:26 98:26 +18 3.71 90/4 Oct 92n 101:21 101:23 - 1 3.39 871 Nov 98n 111:09 111:11 + 5 6.66 T/4 Oct 92n 101:08 101:10 .... 3.53 On Jan 99 98:13 98:15 + 46.67 1/4 Nov Yn 101:13 101:15 3.56 8/1 Feb 99 111:11 111:13 + 6 6.71 8/ Nov 2n 101:20 101:22 - 1 3.57 7 Apr 99n 101:20 101:72 + 5 6.69 10/2 Nov 22n 102:13 102:15 .... 3.48 81/2 May 94-99 105:31 106:07 + 1 4.96 TA Nov 92n 101:14 101:16 .... 3.56 9/1 May 99 112:21 112:23 + 5 6.78 71/4 Dec 22 101:72 191:24 .... 3.57 8 Aug 99 106:19 106:21 + 4 6.80 911 Dec 102:18 102:20 - 1 3.60 TA NOV 99 105:25 105:27 + 6.85 8°/4 Jan 93n 102:18 102:20 .... 3.66 1 Feb 95-00 104:10 104:14 + 26.01 7 Jan 93n 101:24 101:26 .... 3.75 BV1 Feb Oon 109:09 109:11 + 46.90 4 Feb 93 97:18 98:02 + 7 7.30 B' May Oon 11:15 11:17 + $ 6.95 14 Feb 93 101:23 101:27 ... 3.67 PA Aug 95-00 106:14 106: 18 + 3 6.03 717 Feb 93 102:12 102:16 ... 3.70 8/4 Aug oon 110:24 110:26 + 56.98 81/4 Feb 93n 102:18 102:20 .... 3.86 8V2 Nov Oon 109:06 109:08 + 5 7.02 81 Feb 93n 102:21 102:23 .... 3.83 1/4 Feb 0in 104:12 104:14 + 7 7.05 10 Feb 93n 104:05 104:07 - 1 3.82 11/4 Feb 01 129:26 129:30 + 6 7.05 014 Feb 93n 101:26 101:28 + 1 3.82 8 May Oin 105:26 105:28 + 6 7.10 7 Mar 93n 102:09 102:11 .... 3.87 131. May 01 139:15 139:19 + 6 7.04 95% Mar 93n 104:03 104:05 ... 3.84 TA Aug 0in 104:29 104:31 + 5 7.12 TA Apr 93n 102:18 102:20 .... 3.91 8 Aug 96-01 104:29 105:01 + 46.58 1 Apr 93n 102: 12 102:14 .... 3.95 13 Aug 01 141:22 141:26 + 5 7.07 7 May 93n 102:31 103:01 ... 4.00 7 Nov oin 102:10 102:12 # 5 7.15 85/ May 93n 103:26 103:28 .... 3.99 159/6 Nov 01 158:20 158:24 - $ 7.06 1011 May 93n 105:03 105:05 .... 3.97 141/4 Feb 02 149:10 149:14 + 0 7.07 6/4 May 93n 102:11 102:13 .... 4.01 7/2 May 02n 102:26 102:28 + 8 7.09 7 Jun 93n 102:25 102:27 ... 4.02 115/ Nov 02 131:31 132:03 #10 7.18 81. Jun 93n 103:28 100:30 4.00 10°/4 Feb 03 125:18 125:22 + 2 7.24 7/4 Jul 93n 103:05 103:07 + 1 4.01 10°/4 May 03 125:29 126:01 + ? 7.25 68 Jul 93n 102:25 102:27 4.13 119 Aug 03 128:29 129:01 + 7 7.27 8 Aug 93n 104:02 104:04 ... 4.16 11 Nov 03 134:30 135:02 + 7 7.28 85/1 Aug 93 104:23 104:25.4.18 12 May 04 139:21 139:25 + 6 7.30 8°/4 Aug 93n 104:28 104:30 ... 4.16 139/4 Aug 04 151:00 151:07 +10 7.31 11 Aug 93n 108:09 108:11 +1 4.11 1157+ Nov 04 133:23 139:27 + 8 7.40 on Aug 93n 102:12 102:14 ... 4.19 81/4 May 00-05 106:02 106:06 # 7 7.21 6%. Sep 93n 102:07 102:09 + 1 4.21 12 May 05 137:11 137:15 + 6 7.63 81/4 Sep 93n 104:24 104:26 .... 4.21 109/4 Aug 05 127:11 127:15 10 7.43 7 Oct 93n 103:15 103:17 4.26 01 Feb 06 116:18 116:22 +12 7.41 6 Oct 03n 102:02 102:04 + 1 4.33 75 Feb 02-07 102:03 102:07 + 7 7.30 PA4 Nov 93n 104:13 104:15 + 1 4.33 TA Nov 02-07 103:11 103:15 + 1 7.39 8571 Nov 93 105:18 105:20 + 1 4.32 8 Aug 03-08 106:26 106:30 + 7 7.45 Naron in niin mi AA e). May mà m và MORTGAGE-BACKED SECURITIES Representative Issues, quoted by Salomon Brothers Inc. REMAINING WTD-AVG PRICE PRICE CASH YIELD TERM LIFE (JULY) CHANGE FLOW CHANGE (Years) (Years) (Pts.-32ds) (32ds) YIELD (Basis pts.) 30-YEAR GNMA 8.0% 29.6 10.5 201-14 + 7 7.84% 4 FHLMC Gold 8.0% 29.3 7.3 100-30 - 2 7.86 + 1 FNMA 8.0% 29.4 7.9 100-24 - 2 7.87 + GNMA 9.0% 29.3 8.6 106-09 + 4 7.89 - 3 FHLMC Gold 9.0% 29.2 6.3 105-14 - 2 7.79 + FNMA 9.0% 28.3 6.3 105-12 - 2 7.74 + . GNMA 10.0% 29.0 3.8 109-02 + 2 6.99 3 FHLMC Gold 10.0% 27.6 2.3 107-22 unch 6.13 + 4 FNMA 10.0% 27.8 2.3 107-24 unch 5.98 unch 15-YEAR GNMA 8.0% 14.5 6.4 103-24 + 4 7.24% 3 FHLMC Gold 8.0% 14.6 5.2 103-13 + 4 7.18 FNMA 8.0% 14.7 5.7 103-06 + 4 7.24 *Based on projections from Salomon's prepayment model, assuming interest rates remain unchanged from current levels By ANDREA GERLIN Staff Reporter of THE WALL STREET JOURNAL NEW YORK - After the late Solomon Keith bought a lottery ticket at the Chirag Newsstand on Wall Street in 1987, his number came up not once but twice. Mr. Keith won a $5 million share of a larger jackpot but didn't live to enjoy much of it. Unfortunately, the 55-year-old bank janitor died in an auto accident 15 months later, not long after collecting the second of 21 annual installments of $240,245 each, As a result, surrogate's court in lower Manhattan will be the scene of some unusual bidding tomorrow morning when Mr. Keith's $3.8 million taxable lottery proceeds - the remainder after he and his heirs collected five payments-are offered in an estate auction. This time, the award will cost more than the "dollar and a dream" advertised by New York state's lottery. A minimum bid of $1.3 million has already been set in this latest of gambles on interest rates. Although the $240,245 annual payments may look attractive, would-be investors should bear in mind that the end payment in 2007 would have a net present value of $68,281, discounted at 8.18% annually. Charles Milo, an attorney involved in the auction, declines to speculate about whether the minimum bid is a bargain or how much the prize may fetch. "That's for each individual to calculate, depending on what they think the future of interest rates is going to be," he says. Using the 15-year Treasury bond at recent yields as a benchmark, a Wall Street financial analyst predicts that the successful bid is likely to hover around $2.1 million. But if a bidder were to walk away with rights to the payments in exchange for the minimum $1.3 million, the financial analyst figures that the investor will have parked the money in the equivalent of a 17% investment. And while that yield would be high, the risk is low, because the state isn't likely to default. In the past, living prize winners have sold their lottery futures in private auc- tions, but many states prohibit such trans- actions. New York state allows them only with a judge's app val. A public estate auction is even less common. The lucky bidder will buy into an exclusive club of 800 grand prize winners. Merely playing this game may require membership in an exclusive club, though: Bidders must present a certified or bank check payable to the public administrator of New York for $130,000. 2 3