1. Assume you just won $35 million in the Florida lottery, and hence the state will pay you 20 annual payments of 1.75 million each beginning immediately. If the rate of return on securities of similar risk to the lottery earnings (e.g., the rate on 20-year U.S. Treasury bonds) is 6 percent, what is the present value of your winnings?
2. Consider the following investment cash flows:
Year Cash FLOW
0 ($1,000)
1 250
2 400
3 500
4 600
5 600
a. What is the return expected on this investment measured in dollar terms if the opportunity cost rate is 10 percent?
b. Provide an explanation, in economic terms, of your answer.
c. What is the return on this investment measured in percentage terms?
d. Should this investment be made? Explain your answer.
3. Assume that two investments are combined in a portfolio.
a. In words, what is the expected rate of return on the portfolio?
b. What condition must be present for the portfolio to have lower risk that the weighted average of the two investments?
c. Is it possible for the portfolio to have lower risk than that of either investment?
d. Is it possible for the portfolio to be riskless? If so, what condition is necessary to create such a portfolio?