1. Ellie just learned that when she turns 50 she will inherit $1,000,000 from a long lost Aunt. According to her Aunt’s will, the money will be placed in a safety deposit box which she cannot open until she is 50. Ellie is currently 20 years old. While she is grateful for the inhertance, she wished that her Aunt had bought US Treasuy Bonds that would yield a return while her inheritance is held in escrow. She looks up the rate of return on US Treasury Bonds that mature in 30 years and determines that they yield 2.31%.
A- What would Ellie’s inheritance be worth when she turns 50 if the money was invested in Treasury Bonds instead of left in the safety deposit box?
B- What is the present value of Ellie’s inheritance if it was held in a safety deposit box?
C- Ellie, having taken a finance course, decides to go to the bank and borrow money using the inheritance as collateral. She negotiates a deal where the entire amount borrowed and interest is paid back in one lump sum upon receiving the inheritance. The bank agrees that the will is valid, but is concerned that the $1M is not payable if Ellie passes away before she turns 50. The bank decides on a 5% interest rate for the loan to take into account this risk. How much would Ellie be able to borrow assuming the $1M inhertance she recieves at age 50 is used to pay back all of the principal and all of the accrued interest? In other words, she pays neither principal nor interest until she receives the inheritance.
D- Ellie is very optimistic. She expects the S&P 500 to return 10% per year for the next 30 years. If Ellie borrows the amount of money in Part C and invests it all in stocks, how much money will she have in 30 years?
E- What if the S&P 500 only returns 4% per year. Will she be able to repay the bank? Careful here. Think about the all of the cash flows when she turns 50.