# HW #1 (answers) - 1(20 Points G iven the state of the...

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1. (20 Points) Given the state of the economy, you decide that it is time to save for your looming unemployment. You have \$10,000 to put into an FDIC insured CD at your local bank. If the CD offers an APR of 2%, how much will you have accumulated in 1 year? FV = 10,000(1.02) = 10,200 How much will you have in 5 years? FV = 10,000(1.02)^5 = 11,040.81 Instead of investing in the CD your buddy, who runs a venture capital firm, tells you his fund can earn you 20% a year. How much will you have accumulated in 1 year at your buddy’s VC firm? FV = 10,000(1.20) = 12,000 How much will you have in 5 years? FV = 10,000(1.20)^5 = 24,883.20 What if the CD offered monthly compounding? Would it be worth more than the venture capital investment in 1 year? FV = 10,000(1 + (.02/12))^1*12 = 10,201.84 Why wouldn’t you always invest in the fund offering 20% returns? Can’t you earn more money than you would in the CD? Discuss. While your buddy may promise you 20%, a venture capital fund is going to be a much riskier investment than an FDIC insured CD at your bank.

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In expectation, you may earn a larger return with the VC fund, but you will put your capital (your \$10,000) at considerable risk to do so…think of what happened to risky assets during the 4 th quarter of 2008. If you needed this money in the near future, you would not risk your capital in the VC fund.
2. (20 Points) Your buddy Earl is 23 years old. Earl’s goal has always been to have \$1,000,000 in his trust fund by the age of 30. However, he is concerned that last year’s bear market has really hurt his chances. If Earl currently has \$400,000 in his trust fund and expects to earn 7% a year until the age of 30, will he reach his goal? 1,000,000 = 400,000 (1+.07)^t we need to solve for t T = 13.54 , he won’t make his goal What age will Earl be when he makes \$1,000,000? Around 36.5 What if Earl were able to earn 12% APR? 1,000,000 = 400,000 (1+.12)^t we need to solve for t T = 8.08 , he still won’t make his goal What rate would Earl have to earn each year to make his goal? 1,000,000 = 400,000 (1+ r)^7 we need to solve for r r = 14% What if Earl also added \$10,000 per year (at the end of each year) and the account yields 7% APR? Will he reach his goal? 1,000,000 = [400,000 (1+.07)^t]

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HW #1 (answers) - 1(20 Points G iven the state of the...

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