Advanced Financial Management Assignment
Q1. In September 2007, Democratic presidential candidate Hillary Rodham Clinton suggested that every child born in the United States should get a $5,000 "baby bond" from the government to help pay for future costs of college or buying a home. Assume this suggestion is accepted and the every baby born in America is given a $5,000 account at birth.
1) If the money is invested at an annual return of 10%, how much will the account have by the time that young person turns 18?
2) If the young person needs to get $40,000 from the account when he/she turns 18, at what interest rate should be money be invested?
Q2. Suppose that you are age 25 now and you want to be a millionaire when you retire at age 65. You have 40 years to accumulate wealth. At the end of each year you can invest $4,000 in your retirement account till age 65. Please answer the following two questions:
1) Suppose your money will be invested in the stock market. Historically, the U.S. stock market has earned an average annual return of 12%. To be conservative, we assume that the return on your investment for the next 40 years will be a constant of 10% each year. Can you become a millionaire by age 65? Please show your calculations.
2) Suppose your money will be invested in U.S. government bonds. Assume that the return over the next 40 years will be a constant 8% each year. Can you become a millionaire by age 65? Please show your calculations.
Q3. Congratulations! You have just won a lottery and have a choice between the following two alternatives:
(1) $12,000 per year for 20 years;
(2) $50,000 today and $300,000 twenty years later.
If the appropriate discount rate is 10%, which option should you choose and why?
[Hint: Calculate the PV of each alternative]
Q4. As a financial planner, your client has just retired and is interested in purchasing a 30-year annuity that has a guaranteed monthly payment of $2,000. The interest rate for the annuity is 6%. Your client has saved $300,000 for this financial product. Can your client afford this annuity? Please explain.