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. 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?

1. 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? 2. 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? 3.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 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 approval. 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. Tables for Problem #3 are extracted from The Wall Street Journal, July 2, 1992 TREASURY BONDS, NOTES & BILLS MORTGAGE-BACKED SECURITIES Representative Issues, quoted by Salomon Brothers Inc. REMAINING WTD-AVG PRICE PRICE TERY UFE (JULY) CHANGE (Years) (Y ) (Pt-3205) (32ds) CASH YIELD FLOW CHANGE YLELD(Basis pts) 29.3 29.3 29.2 Wednesday, July 1, 1992 Representative Over the Counter quotations based on transactions of 31 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 boldlaced. For bonds callable 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. 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 inds: 101:01 means 101 1/32. Net changes in 32nds. Ylelds calculated on the asked quota- tion.cl-stripped coupon Interest, bo-Treasury bond, stripped principal. no-Trea- sury note, stripped principal. For bonds callable prior to maturity, Vields 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 Maturity Rate Mo/Yr Bid Asked Cho. Yld. Rate Mo/Yr Bld Asked Cho. Yld. PA Nov 97 11:04 11:06 + 5 6.38 10 Jul 2n 100:07 100.09 - 10.95 TA Jan 106:17 106:19 + 46.44 8 Jul 100:11 100:13 ... 87 Feb 98 107:20 107:22 + 3 6.47 4/4 Aug 2 8 :31 99:15 .... Apr 98 106:15 106:17 + 46.50 WA Aug 92 100 1310015 May 93-99 101:05 101:1].... 5.31 7 Aug 2n 100:15 100:17 .. May n 111:24 111:26 +46.54 84 Aug 92 100:16 100:18 .... Jul 108:07 108:09 + 5 6.56 87 Aug 2n 100:22 100:24 .. Aug 98 113:04 113:06 + 46.59 871 Sep 2n 101:02 101:04.. Oct 98 102:72 102:24 + 4 650 Pla Seo 9n 101:06 101:08 Nov 98 97:26 98:26 +18 3.71 90/4 Oct 2n 101:21 101:73 - Nov 98 11:09 111:11 + 5 6.66 P! Oct 2n 101:08 101:10 Jan 18:13 :15 + 46.67 Nov 101:13 101:15 Feb 111:11111:13 + 6 A Nov 2n 101:20 101:72 - Apron 101:20 101:72 + 5 6.49 101 Nov 22 102:13 102:15 May 94-99 105:31 106:07 +1 4.96 PA Nov 92 101:14 101:16 May 99 112:21 112:7 + 5 6.70 7/Dec 2n 101:72 191:24 Aug 104:19 106:21 +46.80 9 Dec 2n 10:18 102:20 NOV 105:25 105:27 + 4 6.85 102:18 102:20 Feb 95-00 104:10 104:14 + 26.01 7 Jan 3n 101:24 101:26 .. Feb oon 109:09 109:11 + 46.90 4 Feb 93 97:18 18:02 May Oon 111:15 111:17 + $ 6.95 Feb 3 101:23 101:27 Aug 95-00 108:14 106:18 +) 6.00 7 Feb 93 102:12 102:16 Aug 00n 110:24 110:26 + $ 6.99 81/4 Feb 93 102:18 102:20 Nov 0 109 04 109:03 + $ 7.07 PA Feb 93 102:21 102:23 Feb 01n 104:12 104:14 + 7 7.05 10 A Feb 93n 104:05 104:07 - Feb 01 129:26 129:30 67.05 / Feb 3 101:26 101:28 May On 105:26 105:28 + 6 7.10 7 Mar 93n 102:09 102:11 .. MAY 01 119:15 19:19 +6704 A Mar 93n 104:00 104:05 Aug in 104:29 104:31 7 5 7.12 102:18 10:20 Aug 96-01 104:29 105:01 +46.99 102:12 102:14 Aug 01 141:22 141:26 + 5 7.07 May 93n 107:31 10:01 .. Nov Oin 102:10 102:12 + 5 7.15 103:26 10:23 Nov 01 19:20 19:24 - $ 706 May 93n 105:00 105:05 Feb 02 19:10 10:14 + 6 7.07 102:11 10:12 May 02n 102:26 102:28 + 8 7.09 102:25 12:27 Nov 02 101:31 in 10 7.18 Jun 3n 103:23 100:30 Feb 125:18 125:22 + 2 7.24 100:05 10:07 + May 03 75.29 126.01 + 7 7.25 102:25 102:27 128:29 129:01 + 7 7.27 104:02 104:04 Nov 124:30 135:02 + 7 7.28 104:22 104:25 May 04 129:21 129:25 +6730 Aug 93n 104:28 104:30 Aug 04 151:00 151:07 10 7.31 108:09 108:11 Nov 04 133:23 130:27 + 8 7.40 Aug 93n 107:12 107:14 May 00-05 106:02 106:06 + 7 7.21 Sep 93n 1:02:07 102:09 May 05 107:11 137:15 +670 Sep 93n 104:24 104:26 .. Aug 05 127:11 127:15 +10 7.0 101:15 10:17 Feb 06 16:18 116:22 +12 7.41 102:02 102041 433 Feb -07 107:09 12:07 + 7 730 Nov 93n 104:13 104:15 + 1430 Nov 02-07 103:11 103:15 + 7 7.39 Nov 93 105:18 105:20 + 1432 Aug 00-08 106:26 106:30 7 7.6 Na na 11. MAI 188388111188448882322 30-YEAR GNMA 8.0% 29.6 10.5 101-14 + 7 7.84% - 4 FHLMC Gold 8.1% 7.3 100-30 - 2 7 .86 + 1 FNMA 8.0% 7.9 100-24 - 2 7 .87 + 1 GNMA 9.0% 8.6 106-09 + 4 7 .89 - 3 FHLMC Gold 9.0% 6.3 105-14 - 2 7 .79 + 1 FNMA 9.0% 28.3 6.3 105-12 - 2 7.74 + 1 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 Augu 3359558888 Oct on a The Wall Street Journal, June 30, 1992 Pricey, but Perhaps the Only Way To Buy a Certain Lottery Winner 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 approval. 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. Tables for Problem #3 are extracted from The Wall Street Journal, July 2, 1992 TREASURY BONDS, NOTES & BILLS MORTGAGE-BACKED SECURITIES Representative Issues, quoted by Salomon Brothers Inc. REMAINING WTD-AVG PRICE PRICE TERY UFE (JULY) CHANGE (Years) (Y ) (Pt-3205) (32ds) CASH YIELD FLOW CHANGE YLELD(Basis pts) 29.3 29.3 29.2 Wednesday, July 1, 1992 Representative Over the Counter quotations based on transactions of 31 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 boldlaced. For bonds callable 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. 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 inds: 101:01 means 101 1/32. Net changes in 32nds. Ylelds calculated on the asked quota- tion.cl-stripped coupon Interest, bo-Treasury bond, stripped principal. no-Trea- sury note, stripped principal. For bonds callable prior to maturity, Vields 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 Maturity Rate Mo/Yr Bid Asked Cho. Yld. Rate Mo/Yr Bld Asked Cho. Yld. PA Nov 97 11:04 11:06 + 5 6.38 10 Jul 2n 100:07 100.09 - 10.95 TA Jan 106:17 106:19 + 46.44 8 Jul 100:11 100:13 ... 87 Feb 98 107:20 107:22 + 3 6.47 4/4 Aug 2 8 :31 99:15 .... Apr 98 106:15 106:17 + 46.50 WA Aug 92 100 1310015 May 93-99 101:05 101:1].... 5.31 7 Aug 2n 100:15 100:17 .. May n 111:24 111:26 +46.54 84 Aug 92 100:16 100:18 .... Jul 108:07 108:09 + 5 6.56 87 Aug 2n 100:22 100:24 .. Aug 98 113:04 113:06 + 46.59 871 Sep 2n 101:02 101:04.. Oct 98 102:72 102:24 + 4 650 Pla Seo 9n 101:06 101:08 Nov 98 97:26 98:26 +18 3.71 90/4 Oct 2n 101:21 101:73 - Nov 98 11:09 111:11 + 5 6.66 P! Oct 2n 101:08 101:10 Jan 18:13 :15 + 46.67 Nov 101:13 101:15 Feb 111:11111:13 + 6 A Nov 2n 101:20 101:72 - Apron 101:20 101:72 + 5 6.49 101 Nov 22 102:13 102:15 May 94-99 105:31 106:07 +1 4.96 PA Nov 92 101:14 101:16 May 99 112:21 112:7 + 5 6.70 7/Dec 2n 101:72 191:24 Aug 104:19 106:21 +46.80 9 Dec 2n 10:18 102:20 NOV 105:25 105:27 + 4 6.85 102:18 102:20 Feb 95-00 104:10 104:14 + 26.01 7 Jan 3n 101:24 101:26 .. Feb oon 109:09 109:11 + 46.90 4 Feb 93 97:18 18:02 May Oon 111:15 111:17 + $ 6.95 Feb 3 101:23 101:27 Aug 95-00 108:14 106:18 +) 6.00 7 Feb 93 102:12 102:16 Aug 00n 110:24 110:26 + $ 6.99 81/4 Feb 93 102:18 102:20 Nov 0 109 04 109:03 + $ 7.07 PA Feb 93 102:21 102:23 Feb 01n 104:12 104:14 + 7 7.05 10 A Feb 93n 104:05 104:07 - Feb 01 129:26 129:30 67.05 / Feb 3 101:26 101:28 May On 105:26 105:28 + 6 7.10 7 Mar 93n 102:09 102:11 .. MAY 01 119:15 19:19 +6704 A Mar 93n 104:00 104:05 Aug in 104:29 104:31 7 5 7.12 102:18 10:20 Aug 96-01 104:29 105:01 +46.99 102:12 102:14 Aug 01 141:22 141:26 + 5 7.07 May 93n 107:31 10:01 .. Nov Oin 102:10 102:12 + 5 7.15 103:26 10:23 Nov 01 19:20 19:24 - $ 706 May 93n 105:00 105:05 Feb 02 19:10 10:14 + 6 7.07 102:11 10:12 May 02n 102:26 102:28 + 8 7.09 102:25 12:27 Nov 02 101:31 in 10 7.18 Jun 3n 103:23 100:30 Feb 125:18 125:22 + 2 7.24 100:05 10:07 + May 03 75.29 126.01 + 7 7.25 102:25 102:27 128:29 129:01 + 7 7.27 104:02 104:04 Nov 124:30 135:02 + 7 7.28 104:22 104:25 May 04 129:21 129:25 +6730 Aug 93n 104:28 104:30 Aug 04 151:00 151:07 10 7.31 108:09 108:11 Nov 04 133:23 130:27 + 8 7.40 Aug 93n 107:12 107:14 May 00-05 106:02 106:06 + 7 7.21 Sep 93n 1:02:07 102:09 May 05 107:11 137:15 +670 Sep 93n 104:24 104:26 .. Aug 05 127:11 127:15 +10 7.0 101:15 10:17 Feb 06 16:18 116:22 +12 7.41 102:02 102041 433 Feb -07 107:09 12:07 + 7 730 Nov 93n 104:13 104:15 + 1430 Nov 02-07 103:11 103:15 + 7 7.39 Nov 93 105:18 105:20 + 1432 Aug 00-08 106:26 106:30 7 7.6 Na na 11. MAI 188388111188448882322 30-YEAR GNMA 8.0% 29.6 10.5 101-14 + 7 7.84% - 4 FHLMC Gold 8.1% 7.3 100-30 - 2 7 .86 + 1 FNMA 8.0% 7.9 100-24 - 2 7 .87 + 1 GNMA 9.0% 8.6 106-09 + 4 7 .89 - 3 FHLMC Gold 9.0% 6.3 105-14 - 2 7 .79 + 1 FNMA 9.0% 28.3 6.3 105-12 - 2 7.74 + 1 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 Augu 3359558888 Oct on a