HPK Search

Search High Paying Keyword Fenomenal - 2016

Copyright © HPK Search | Published By Gooyaabi Templates | Powered By Blogger
Design by WebSuccessAgency | Blogger Theme by NewBloggerThemes.com
Powered by Blogger.
Showing posts with label mathematics. Show all posts
Showing posts with label mathematics. Show all posts

Tuesday, November 27, 2012

Should you buy all 175.2 million Powerball combinations?

Update 1: The Powerball annuity jackpot has been increased to $500 million, and the cash value is now $327 million. (Tuesday, Nov 27 3:31 PM)
 
With the Powerball jackpot now at $425 million, it is logical for players to wonder if they should buy tickets for all the possible combinations. At first glance, one might think this would be a winning strategy for picking up an easy $74.6 million. 

However, before one recklessly spends this much money, there are several factors that that must be considered.
  1. In the 2012 Powerball game, each ticket costs $2. Since there are approximately 175.2 million combinations, one would have to spend $350.4 million to accomplish this.
  2. The $425 million jackpot is the annuity value which is paid in 30 varying installments (29 years). This implies that the breakeven 0 profit financing rate is 1.144%. So, if one borrowed the $350.4 million, the borrowing rate must be less than this interest rate in order to make a profit. If the borrowing rate is more than 1.144%, you will lose money.
  3. The cash value being offered today is $278.3 million. If you take the cash, you will immediately lose $72.1 million.
  4. In order to guarantee yourself a winning ticket, you must buy all the 175.2 unique combinations. If you are lazy and buy 175.2 quick picks, then there is a 36.8% chance that you will not have the winning combination.
  5. When the jackpot is this high, we can expect that approximately 120 million other tickets will be sold. Of these, there will be a 50% chance that one of these will be a winning ticket. This means that there is a 50% chance that you will have to share the jackpot prize with at least 1 other winner. If this happens, you might win only $212.5 million annuity or $139.2 million cash or less. Again, you will take a loss.
As you can quickly see, there is a very high probability that even if you buy all the unique combinations, you will end up losing millions of dollars if you purchase all the combinations. Thus, our advice is:

No, You should NOT but all the Powerball combinations.

But, what if no one wins the jackpot in the next drawing and the Powerball grows to $600 million. Should you buy the combinations then?
To help you answer this, we present the two graphs below. The first shows the chances of there being a losing Powerball as ticket sales grow to 500 million. As you can see, the chances decrease as sales increase. When 200 million tickets are sold. there is a 30% chance that nobody will win. When ticket sales hit 500 million, there is less than a 6% chance that there will be no winner.


The second graph shows the probabilities of having more than one winner. At sales of 200 million, there is a 40% chance of multiple winners. When sales reach 500 million, there is a 67% chance that there will be more than one winning ticket.


So, even as the temptation to purchase all combinations increases as the jackpot value grows, the likelihood that the prize will be shared by more than one winner also increases. So, even if the annuity jackpot reached $1 trillion, it would most likely be shared by 2 or more winners, which means that each winner would only receive a jackpot prize equal to or less than the $425 million currently offered.

Thus, we continue to recommend that you should:

NEVER buy all the Powerball combinations!

Tuesday, October 2, 2012

Introducing the Lottery Probability Surface

In an effort to help players find a financially feasible strategy for playing the lottery, we discovered an important organization inherent in all lottery games.  By reducing all the combinations of a particular game into individual sum and range buckets, and then totaling those occurrences, have identified each game's "probability surface".

The surface is constructed using the only the primary white balls and not the bonus balls.  One axis of the surface consist of the Sum of all the balls.  And, the second axis is defined by subtracting the last ball from the first ball (the X and Y axis are interchangeable).

Doing this, for Pick 3 and 4 games which allow all selection for replacement, the resulting surface is that of a diamond. The reason for this pattern is that the last ball may be less than, equal to, or greater than the first ball, thus allowing the Range to progress from negative to positive values.  The illustration below is a 3-D view of the Pick 4 probability surface.


Pick 4 Lottery Probability Surface (3-D)
3-D Image of Pick 4 Lottery Probability Surface

For those games which do not have replacement (such as Mega Millions, Powerball, Lotto 649, Texas 2 Step, etc), we ignore the order drawn and sort the numbers from lowest to highest value. Doing this, we define a shape that is trapezoidal in shape. The illustration below is a 3-D view of the Texas 2 Step probability surface. This shape similar to that of Powerball, Mega Millions, etc. However, its scale is more condensed.

Texas 2 Step Lottery Probability Surface (3-D)
Texas 2 Step Lottery Probability Surface (3-D)

During the coming months, we will publish the probability surface characteristics for each of the lottery games that we cover.  In addition, we will be adding new analytic pages to our website summarizing the historical data of each game.

Our first application using this new discovery will be the Pick 4 games. We are well into the development of studying the New Jersey Pick 4 and hope to release this in the next few weeks. Following that, we will apply the same template to analyzing the Pick 4 games which we can easily obtain the complete drawing histories (California, Texas, North Carolina).

JL ..........

Wednesday, October 27, 2010

Estimating Probability of Back to Back Lottery Jackpot Winners Using the Poisson Distribution - Part 3

Part 3: Introduction
In our previous article, we provided an example of how the Poisson Distribution could be used to estimate the probability of multiple jackpot winners (Poisson Distribution Example of Use in Lotteries - Part 2). To carry the application of this statistical model forward, we will calculate the likelihood of there being back to back lottery jackpot winners in both Powerball and UK Lotto. We choose these two games because the frequency of winners in these two games vary immensely.


Poisson Distribution Utilization Review
The Poisson Distribution is a tool used to predict the probability of a discreet event occurring. To use it, there must be a clearly defined observed set of outcomes. Those outcomes are summarized and described as a single average. The distribution of varying events therefore becomes a function of this average.

For example, assume that we wish to define the probability that we will observe 3 automobiles queued at a stop light. The traffic signal changes to red only once an hour. From our previous collection of data, we know that the average length of the queue is 4.8 cars per hour. Substituting these numbers into our Poisson equation, we find that there is a 15.2% chance that the following queue will contain 3  cars.

Now we shall apply these same principles to estimating the probability of a lottery jackpot being won two consecutive drawings in a row.


Example 1: Estimating the Probability of Back to Back UK Lotto Jackpot Winners.
The UK Lotto is the national lottery of the United Kingdom. Since it is a 6/49 game, the approximate number of combinations is about 14 million. By U.S. standards, this is rather small. Being the country's primary game, the average drawing ticket sales range from approximately 14 to 32 million.

Since ticket sales meet or exceed the number of combinations, the UK Lotto jackpot is won on an average of every 1.283 drawings. To calculate the likelihood of there being successive jackpot winners, we must reduce this average by one (to 0.283), and solve for the 0 (zero) event. In effect, we do this to change from a one base to a zero base.

Solving, we find that there is a 75.4% chance that two UK Lotto jackpots will be won in two consecutive drawings. By comparison, we calculated that back to back winners occurred 77.9% of actual time.


Example 2: Estimating the Probability of Back to Back Powerball Jackpot Winners.
By comparison, Powerball is one of two national lotteries of the United States. Its format requires players to correctly pick 5 of 59 white balls and 1 of 39 Power balls in order to win the jackpot. Expanding this out, we find that there are over 195 million possible combinations. Since this is so large, the jackpot is not won as often as the UK Lotto.

Summarizing Powerball drawing results from 2001 to present, we learn that there are approximately 8.95 drawings between jackpot winning draws. Converting this average to a zero base (7.95 average) and solving for the 0 event (back to back winners), we calculate that there is only a 0.04% chance that there the jackpot will be won in two sequential drawings.

By counting the actual number of times this has occurred in Powerball, we find this happened only 7 times since 2001, or 0.68% of the time.


Conclusion
Comparing the expected probabilities derived from the Poisson distribution to the actual number of occurances, we conclude that the statistical results of back to back winners is a fairly good approximation of reality. While the Poisson distribution underestimates reality in both cases, we believe that the results obtained can be confidently used to predict these lottery events.
Enhanced by Zemanta

Wednesday, October 20, 2010

Poisson Distribution Example of Use in Lotteries - Part 2

Part 2: Introduction
Last week we introduced the Poisson Distribution stating that it is used in statistics for quantifying the probabilities of discreet  random events. In our post Using Poisson Distribution to Understand Lottery Events - Part 1, we described its mathematical properties, formula, and variables. In this article, we will provide an example of how the Poisson Distribution can be used to help us understand events related to lotteries.


Example: Estimating the Probability of Multiple Jackpot Winners.
In this example, we will estimate the the probability that there will be 0, 1, 2, ... 5 winning tickets in tonight's Mega Millions lottery drawing which offers an annuity jackpot of $84 million.

In order to do this, we must first calculate the "expected number of winners" as defined in How to Analyze the Lottery. There, we learn that we need 2 pieces of information:
  1. The expected number of ticket sales, and
  2. The total number of unique combinations.
Using Mega Millions Lottery Sales By State, we find that last Friday's ticket sales were 25.4 million when the jackpot was $72M. Using a simple proportion, we will expect tonight's tickets sales to be 29.6 million. Then, from our Lottery Power Picks website, we find that there are 175.7 million combinations. By dividing the expected number of ticket sales by the total number of available combinations, we calculate the "expected number of winners" to be 0.169. In Poisson Distribution terms, this number becomes the known mean, or constant variable r = 0.169

Next we construct a table where: the mean variable r remains constant; and the variable k (which represents the random number of winners) ranges from 0 to 5; and, the associated Poisson probability is solved as variable p(k).


rkp(k)
0.16900.8445
0.16910.1427
0.16920.0121
0.16930.0007
0.16940.0000
0.16950.0000


Thus reading our table, we learn that there is: an 84.45% chance that there will be no winners in tonight's Mega Millions drawing; a 14.27% chance that there will be one winner; a 1.21% chance that there will be 2 winners; a 0.07% chance that we will have 3 winning tickets; and virtually 0.0% chance that there will be four or more winners.

So, we'll look tomorrow at the Mega Millions drawing results to determine which of our random scenarios occurred.

Wednesday, October 13, 2010

Using Poisson Distribution to Understand Lottery Events - Part 1

Introduction
The Poisson Distribution is a statistical model used to project the probability of the occurrence of discreet events. Recently, we have discovered the use of this model in an article, How to Analyze the Lottery, by John Corbett and Charles Geyer. In it, the authors explain how a Cash/Annuity lottery works by evaluating the probability of single and multiple winners.

Based on their work, we have explored the potential use of this model to understand other lottery events.

Thus, to present this information, we are splitting this discussion into 3 parts:
  • Part 1: Definition of the Poisson Distribution
  • Part 2: Examples of Use
  • Part 3: Comparison of Expected Probabilities Verses Actual Events
Today's article Presents Part 1 of our Analysis.


Definition of the Poisson Distribution
The Poisson Distribution  is a statistical model that expresses the probability of a random event occurring in a fixed period of time when:
  • The there is a known average of occurrences
  • It is possible to count the number of times an event has occurred
  • Each occurrence of an event is independent of the previous results
  • Expected events (except the average) must be a whole positive integer
As a formula, the Poisson Distribution is written as:

Poisson Distribution

Poisson Formula

where:
k = the whole integer expected random event event
r = the known mean or average (often represented as lambda)
p(k) = the solved Poisson Distribution probability of event "k"

Note that depending on the text referenced, the variables may be different, and the representation may be slightly different as well (showing the e^r term on the top as e^-r).

The graph below illustrates a sample Poisson Distribution. The vertical y axis shows the probability of an event happening. The horizontal x axis shows variable random occurrences. Note that the probabilities are skewed towards the left where the average occurs. Additionally, the horizontal axis is boundless. Meaning it must never have a discreet limit.





Potential Uses in Lottery Analysis.
When analyzing the lottery, the Poisson Distribution has several applications. For example, we may use it to quantify the probabilities of:
  • Multiple Winners in any Single Drawing, or
  • The the Number of Drawings before a Jackpot is Won


Next Week's Publication - Part 2
As stated above, this will be a three part series. Next week we will illustrate the use of the Poisson Distribution by showing how to estimate the number of winners and the interval between winning jackpot drawings.


To Learn More, please visit:

Enhanced by Zemanta

Wednesday, October 6, 2010

Next Weeks Bimonthly Article Announcement - Poisson Distributions

I've been reading a lot about probabilities lately and have discovered a few great articles pertaining to Poisson Distribution.

So, I've started working on a post which will be titled:

Using Poisson Distribution to Understand Lottery Events

I thought this would be easy, but the more I've researched it, the more I am learning. So for now, I expect to have this complete and published next week.

JL................

Wednesday, September 29, 2010

Lottery Wheel Payout Calculator --- Coming Soon

[Irish spinner and spinning wheel. County Galw...Image by The Library of Congress via Flickr
With the completed development of our Hot Cold Lottery Number analysis pages and seeing their growing user visitation counts, six questions continually return to our minds. Specifically, we've wondered:
  1. If I only play Hot Numbers, how many combinations must I play?
  2. How much will these combinations cost?
  3. How much will I win in total if I match 0, 1, 2, ... white balls?
  4. If I repeat these combinations for a group of bonus balls (Megaball, Powerball, etc), how much will I spend?
  5. And, how much will I win altogether?
  6. Finally, if I adopt this type of strategy, should I buy the Powerplay, Megaplier, Sizzler option?
To answer these questions, we're creating a new wheeling payout calculator that will be custom tailored to each of our covered lotteries. This will be an interactive tool that will allow our users to change their assumptions and the implications immediately.

The benefit of this calculator is that any assumed set of wheeling numbers can be used, i.e. Even Odd, Divisible by 3, 4, 5 to 12, your own favorite set of numbers, prime numbers, etc.

Development has already begun and we're excited about the possibilities of its uses.  Hopefully, we will have it completed shortly and have it released within the next month.
Enhanced by Zemanta

Saturday, September 27, 2008

Chances of Duplicate Lottery Tickets - Special Edition

Introduction
We've often wondered what the likelihood of different lottery players having the same combinations in a single drawing actually was. Looking for an answer, we searched the internet, but could not find it. So, we decided to conduct our own research. This was performed by studying the classic Identical Birthday Problem, identifying the underlying mathematical formula, applying this formula to individual lotteries, and summarizing our results.

Birthday Problem
How often have you been in a group of people and discovered that two of you shared the same birthday? Was this purely coincidence, a random event? Or, was it in fact highly likely?

The classic form of the Birthday Problem, which is familiar to most everyone, quantifies the chances of two people sharing the same birthday. Given a probability of certainty, the Birthday Problem solution calculates the size of smallest group necessary to meet that probability.

Thus, when in a group of 23 (22.5 actually) people, you can be 50% certain that two or more of you share the same birthday. To be 99.9% sure, you need a group of 71 people!

The Mathematics
The formula behind this solution is fairly simple, and in terms of Excel is written as:

SQRT(2*PopulationSize*LN(1/(1-Probability)))

We solve the Birthday Problem by substituting the PopulationSize with 365 days and the Probability of 0.50 or 0.999 to acheive the answers above.

Calculating the Chances of Duplicate Lottery Tickets
We applied the formula above to the various lottery games that we cover and produced the Chance of Duplicates Table below.

The first column identifies the lottery Game. Next is the Population (total number of possible combinations) for that game. The 3rd and 4th columns are our results. Column A identifies the minimum number of tickets that must be issued in order to be 50% sure that there at least one duplicate. Column B is similar, but identifies the minimum number of tickets that must be issued in order to be 99.9% sure that there at least one duplicate.

Chance of Duplicates
GamePopulationCol A
50%
Sure
Col B
99.9%
Sure
Powerball146,107,96214,232.044,928.3
Powerball (Jan 09)195,249,05416,452.151,937.1
Mega Millions175,711,53615,607.349,270.1
Lotto 64913,983,8164,402.913,899.4
Super 762,891,4999,377.429,476.7
Super Lotto Plus41,416,3537,577.323,920.5
Hot Lotto10,939,3833,894.312,293.6
EuroMillions76,275,36010,283.032,462.0
Irish Lotto8,145,0603,360.310,607.9
UK Lotto13,983,8164,402.913,899.4
Thunderball3,895,5842,323.97,336.2
Birthdays36522.571.0

The Chances
As shown, the chances that duplicate lottery tickets will be sold are very likely. For example, there is a 50% chance that duplicate Powerball tickets will be issued when only 14,232 tickets are sold. And, you can be 99.9% sure that there are duplicates when only 45,000 tickets are sold. When Powerball changes format in January 2009, the total number of possible combinations will increase by over 49 million. Even so, you can be 99.9% sure that there will be duplicates when only 52,000 tickets are sold. By reading the table above, you can determine the likelihood of duplicate tickets in your favorite lottery, whether it be: Powerball, Mega Millions, Super Lotto Plus, Hot Lotto, EuroMillions, Irish Lotto, UK Lotto, or Thunderball.

Summary
This study identifies the number of tickets that must be sold in order to be 50% and 99.9% mathematically certain that one or more people will have duplicate combinations. While this information is not sufficient to estimate the total number of duplicate tickets, it provides a guideline to understand the chances. If you live in a small town of around 50,000 people, and everyone buys 1 lottery ticket, don't be surprised if you discover that someone else has the same combination as yours.

JL .........




StumbleUpon Toolbar Stumble It!

Saturday, August 30, 2008

MM Cash or Annuity? The LPP Analysis of the Mega Millions Jackpot

Introduction
Mega Millions players are required to choose whether they wish to receive Cash or Annuity Option at the time of purchase. In most States, the players who choose the Annuity Option may opt to take the Cash Value within 60 days of winning, but those who originally chose the Cash Option may not change their mind. After asking around, we confirmed that most people select the Cash Option, believing this is the best choice. So, if you play Mega Millions, what do you choose:

The Cash or Annuity Option?

Since the beginning of 2002 through Aug 24 2008, seventy-five (75) jackpots have been won by individuals and groups. These are listed in the Mega Million Jackpot History of Winners page. However, the Mega Millions website does not indicate whether these winners had chosen the cash or annuity payouts. But, it does feature profiles of 19 winners in their Winners Gallery. Of these 19, three have chosen the Annuity, and the rest have taken the Cash Option.

This means that around 85%
of Mega Millions players
take the Cash Option.
Is this the best decision?

Or, would they have more money by taking the Annuity?


Real World Example
For purposes of this paper, we have chosen to analyze the Jul 25 2008 Mega Millions drawing. We believe this Jackpot Analysis is relevant because it represents the minimum jackpot payment as defined by the rules, and is current as of this writing.

Graph MM0808a illustrates the Jackpot Offerings for the Jul 25 2008 Mega Millions drawing.


In this drawing, Jackpot winners choosing to receive the Annuity option will be paid $12 million in 26 equal installments spread over a 25 year period. Those who elect the Cash option will receive only one lump sum payment of $7.1 million. Comparing the amounts of both options presented, the Cash to Annuity Ratio for this drawing is 59.2%.

Having little other information, most winners will elect to receive the Cash Option, believing that the $7.1 million is a fair amount within the current interest rate environment.

However, this Cash Option may not be fair.

Therefore, the purpose of this paper is to provide Mega Millions players with more information about their two options. In this, we shall examine both the tax implications of each, and explain how fluctuating interest rates influence the size of the offered Cash Option, and more. By

Analyzing and Comparing the
Cash and Annuity Mega Millions
Options

we believe both players and winners will have a better understanding of the fairness of the estimated cash option being offered in any particular Mega Millions drawing.


How the Cash and Annuity are Paid
In Mega Millions, a Jackpot annuity winner receives 26 equal payments over a 25 year period. This differs from Powerball whose payments are graduated over a 29 year period. Taxes are paid yearly on receipt of each payment, meaning that all accrued interest earned remains tax free until payment is made to the winner.

Conversely, players who choose to receive the Cash Option will receive a single lump sum payment whose estimated value is stated on their web site. Taxes on this full amount is payable in the year received.

Mega Millions describes these different payment options on their page: "Differences Between Cash Value and Annuity".


Mega Millions Annuity Yearly Cashflow Payments
Because each of the Mega Millions Annuity Payments is fixed, the amount of money that the Mega Millions organization must deposit varies, depending on the: length of time until payment is made, and interest rates earned on this money. However, the payments made to the winner is always fixed. This means that players who won $12 million and elected the annuity option, would receive an 26 annual payment of $462 thousand every year.

Assuming that the prevailing interest rates are at an even 4% per year, Graph MM0808b illustrates the 26 annuity cash deposits that would be required by Mega Millions in order to meet these payments.

We have chosen the 4.0% interest rate level because this is the rate that the competing Powerball assumes its reinvestment. By using this same rate, we can reliably compare the cash values of both of these lotteries.




Note: This graph is for an $12 M annuity, but is scalable. If the annuity is $30 M, multiply payments by 2.5; if $84 M, multiply by 7; if $240 M, multiply by 20; etc.

As shown, the blue horizontal line illustrates the constant payment of $462K made to the winner. The vertical green bars illustrate the money required to be deposited. Notice that as the time increases, the amount of money Mega Millions must deposit is reduced. This is because compound interest is being earned on each deposited cashflow. When interest rates are 4.0%, Mega Millions would need $462K for the first payment; $365K for the 5th year; $289K for year 10, ... and finally $143K for the 26th and final payment. The differences between the deposited amount and the $462K payment is the interest earned.

To be fair to the players, the total the 26 deposits should equal to the Cash Value Offered at the time the tickets are being sold. Since we are assuming 4.0% as a fair interest rate, Mega Millions must aside $7.672 Million in order to make these payments of $12 M to you.

We shall define this value of $7.672 million as Par.
The Par Cash to Annuity ratio is 63.9%.


Jul 25 2008 Jackpot Revised
Adding the $7.672 M Par Value to our Jackpot Graph (MM0808c) provides us with a relative measure by which to judge the fairness of the $7.1 million cash option offering. As shown, the Cash Option is $0.572 million below Par. This means that those who elect the Cash Offer immediately lose $0.572 of their winnings. In terms of ratios, we are offered 59.2% verses the par 63.9%, or a 4.7% loss.


Without knowing the prevailing interest rates by which to reinvest our Cash Option, we cannot yet say with certainty that the $7.1 offering is unfair.

But we know for sure that if we take the Annuity, $7.672 M will be set aside for our winnings. If we take the Cash Option, we immediately lose nearly $600,000. This comes out to losing $22 thousand per year.



Fair Value of Mega Millions Cash Option at Varying Interest Rates
Both the Mega Millions organization and us recognize that interest rates vary. Because of this, the value of the cash option will move in the opposite direction of interest rate movements. This means that if interest rates go up, the cash option goes down, and vice-versa. Knowing the fair value of the cash option at various interest rate levels further will help us to judge the fairness of the Cash Option being offered.



Graph MM0808d illustrates the fair value of the cash option value at interest rates varying from 2% to 10%. Note that when interest rates fall below 4%, the cash option increases above our $7.672 M Par Value (green line).

This graph tells us that when interest rates are at 2%, Mega Millions must invest $9.472 million to fund our $12 million annuity. At 3% interest, $8.498 must be deposited for funding. And, when interest rates rise to 10%, only $4.651 needs to be invested.

Referring to this graph, we observe that the July 25 2008 Cash Option of $7.1 M equates to an interest rate environment of slightly less than 5%. Considering that interest rates have fallen substantially during January 2008 and May 2008 (from 4.25% to 2.00%) and continue to remain low, this 5% investment level appears to be rather high.

Thus, the July 25 2008 $7.1 Million Cash Option begins to appear to be rather low.

Note: This graph is for an $12 M annuity, but is scalable. If the annuity is $30 M, multiply amounts by 2.5; if $84 M, multiply by 7; if $240 M, multiply by 20; etc.


Tax Implications
Regardless which option a winner selects, taxes represent a large portion of the income. Winners are automatically moved into the highest tax bracket, and both standard and itemized deductions become limited.

Because of this, we assume that Federal Taxes will consume 35% of one's winnings.

This means that those who elect the $12 million Annuity Option will pay a total of $4.2 million to the IRS. Without paying State taxes (many states do not tax those residents who win Mega Millions),

Annuity winners keep $7.8 million

to spend and invest. One important benefit of taking the annuity is that taxes will only be paid on the amount of money given to the winner each year. All other interest being earned will remain and grow tax free until it is paid out later.

Conversely, those who decide to take the Cash Option will be taxed immediately. In the case of the July 25 2008 cash jackpot, the winner will immediately fork over $2.5 million to the IRS. This means that the cash winner will only pocket $4.6 million. Typically, Mega Millions withholds only 25% of the jackpot winnings. This means that winners will be liable for the remaining 10% when they file their taxes. Most winners do not realize this and are unhappily shocked when they learn about the additional tax consequences.

The website USAMega.com provides excellent Mega Millions Jackpot Analysis pages that summarize both the Federal and State Tax implications on the Annuity and Cash Options.


Cash Value Implied Yield Curves
Knowing that $12 M annuity winners will retain $7.8 million of their winnings after taxes, it is possible to construct the associated Implied Yield Curves that will provide the cash option winners with the same amount of money. Using this $7.8 M value as a target, the Blue Curve displays the Tax Free Rates for varying cash offerings, meaning that the earned interest is not taxed until paid. Whereas, the Green Curve indicates the Taxable Equivalent Curve. The horizontal axis indicates the cash value offering in millions. The vertical axis indicates yield rates.


Note: These Cash Jackpot values are based on a $12 M annuity, and are scalable. If the annuity is $30 M, divide the offered amount by 2.5; if $84 M, divide by 7; if $240 M, divide by 20; etc.


Returning to the July 25 2008 drawing, the Cash Jackpot offering is $7.1 million.

Assuming that this is the fair value, it will be the same amount that Mega Millions will invest for the Annuity winners. From the graph MM0808e Blue Curve, we can guesstimate that Mega Millions will invest this money at approximately 5.0%. The interest earned on the annual payments will compound tax free at this rate and will generate a total of $12 M in payments to the winner. After paying taxes, the player will get to keep the $7.8 million.

However, if the player selects the cash option, he will receive $7.1 million, pay $2.5 M in taxes, and invest the remaining $4.6 million. The Green Curve in graph MM0808e already takes the reduction of taxes into account. So, to find the taxable equivalent yield the player must earn, we locate $7.1 M on the horizontal axis, then find the point on the Green Line above it. Doing this, we find that the cash option winner must receive approximately 6.5% on the remaining $4.6 M in order to earn $7.8 million.


Evaluating the July 25 2008 Cash Offering
Considering the Federal Reserve has reduced interest rates substantially, we know that short term rates are around 2.3%, 10-year Treasuries less than 4.0%, and 30-year treasuries below 4.5%. Thus, it is impossible for Mega Millions to earn an average rate of 5.0% on the annuity deposits at this time. Therefore, we conclude that:

The $7.1 million cash offering is extremely undervalued,
and should be at least $7.7 or more million.


Cash Loss per Million (Mar 14 - Aug 29 2008)
To test the correlation of the Mega Millions Cash Option Jackpot offering against actual changes in interest rates, we have constructed the Cash Loss per Annuity Million graph at right.


We define Cash Loss as the difference between the expected Cash Par Value and the Offered Cash Value, normalized to a single $1.0 million in annuity value.

As shown, the graph covered the 49 drawings beginning March 14 2008 and ending August 29 2008. The magnitude of the loss is displayed on the y-axis, and ranges from $10,000 to $60,000 per annuity equivalent million dollars. The vertical Green Lines indicate when a Mega Millions Jackpot was won and was reset to the minimum $12 M. The horizontal Blue Line indicates the average loss of $30,000 per million.

During this period, the FOMC reduced the Federal Funds Target rate twice:
  • Mar 18 2008 - from 3.00% to 2.25%, and
  • Apr 30 2008 - from 2.25% to 2.00%.
These are indicated by the magenta dots on the graph.

Because the interest rates were lowered, we would expect the Ratio of the Cash Offered Jackpot to Annuity to the closer to the Par Jackpot ratio of 63.9%, thus bringing the Loss per Million closer to zero.

But in reality, the Cash offering by Mega Millions appears to be random. During the period March 18 and April 30 when Fed Funds was 2.25%, the loss spiked to $60K, then dropped to $10K. After the April 30 cut, the losses remained constant, around $30K. Afterwards, the losses grew until the June 13th jackpot win, then fell. When the jackpot was reset on July 25th, the loss unexpectedly jumped to $47 K. Again in this cycle, as the Annuity jackpot has risen, the cash option loss has fallen to only $20 K per million.

Since players and winners had no basis to evaluate the fairness of the cash prize offering, complete trust was placed in the Mega Millions estimate, which appears to be arbitrary, and not really correlated to actual interest rates. Based on all of this, we believe that the:


Mega Millions Annuity Offer is Best!



Summary
To summarize, Mega Millions winners who elect to receive the Cash Option are usually penalized because: the Cash Option Value is under estimated; interest rates are typically lower than that offered by the Annuity; and, taxes erode the both the cash payment and interest earned.

MM Cash Option Breakdown
To visualize the July 25 2008 Cash Offering payout, Graph MM0808g illustrates the Cash breakdown against the comparative $12 million annuity prize. Notice that the player will retain a total of $6.7 million in winnings, consisting of the $4.6 M cash payment and $2.1 M of interest earned. A total of $3.6 million will be paid in taxes. And, $1.7 million will lost to Mega Millions .

Conversely, Mega Millions players who win $12M and elect to receive the Annuity payments will retain $7.8 million in cash, and will pay $4.2 million in taxes.

MM Annuity Breakdown
The net difference in money retained by the winner will be $1.1 million spread over the 26 payments.

This equates to approximately $42.3 thousand dollars per year. This is a lot of money.

Note: All amounts shown are based on a $12 M annuity at 4% interest. These values are scalable. Thus, if the annuity is $30 M, multiply amounts by 2.5; if $84 M, multiply by 7; if $240 M, multiply by 20; etc.



Conclusion
In this discussion, we have: illustrated how the Mega Millions Annuity payments are made; identified the fair cash value Par value of $7.672 million; described the fair cash jackpot offerings at varying interest rates; created the non-taxable and taxable implied break-even yield curves; shown the historical cash loss per million; and summarized the breakdowns of money retained, taxes paid, and money lost.

By focusing on the July 25 2008 cash and annuity jackpot offerings of $7.1 M and $12 M, we have concluded that winners in this drawing are far better off by receiving the Annuity Payments instead of the Cash Option.

Lastly, our advice with regard to this Mega Millions drawing (and most likely others) is to:

Take the Annuity,
You'll have alot More Money
Unless things change.

And remember, if you check the Annuity Option when you buy your tickets, you can change your mind and take the Cash Option (depending in which state you purchase the ticket). Those originally selecting the Cash Option cannot reverse that decision.

Learn More
We have not found many sites that provide detailed Mega Millions Jackpot information. However, you can learn more by visiting the following:
Focus for October: Florida Lotto Plus



StumbleUpon Toolbar Stumble It!

Friday, June 27, 2008

PB Cash or Annuity? The LPP Analysis of the Powerball Jackpot

Introduction
Playing Powerball requires players to make many immediate choices: What numbers to play? Buy the Powerplay? Play quick pick numbers? And, if the player is lucky enough to win the jackpot, the player must then choose whether to:

Take the Cash or Annuity Option?

Since the beginning of 2003 through Jun 18 2008, there have been 76 different winners (groups or individuals) that needed to make this choice (Powerball Winners). Of them, only three have opted for the Annuity; 70 have taken the cash option; 1 is still deciding; and 2 have mixed payments.

Since most players take the Cash Option,
they must be right.

Or, Are they wrong?


Real World Example
For purposes of this paper, we have chosen to analyze the May 31 2008 drawing. We believe this Jackpot Analysis is relevant because it represents the minimum jackpot payment as defined by the rules, and is current as of this writing.

Graph GR0606a illustrates the Jackpot Offerings for the May 31 2008 Powerball drawing.


In this drawing, Jackpot winners choosing to receive the Annuity option will be paid $15 million in 30 installments spread over a 29 year period. Those who elect the Cash option will receive only one lump sum payment of $7.1 million. Comparing the amounts of both options presented, the Cash to Annuity Ratio for this drawing is 47.3%.

Having little other information, most winners will elect to receive the Cash Option, believing that the $7.1 million is a fair amount within the current interest rate environment.

However, this Cash Option may not be fair.

Therefore, the purpose of this paper is to provide players with more information about these two options. In this, we shall examine both the tax implications of each, and explain how fluctuating interest rates influence the size of the offered Cash Option, and more. By

Analyzing and Comparing the
Cash and Annuity
Powerball Options

we believe both players and winners will have a better understanding of the fairness of the estimated cash option being offered in a Powerball drawing.



How the Annuity is Paid
Beginning on October 9, 2002 (Colorado Lotto Powerball Information), Powerball made two significant changes to the annuity payout structure. First, the annuity period for paying the Jackpot was extended from 25 to 30 payments (paid over a 29 year period). Second, each payment (after the first) is gradually increased at a predetermined interest rate of 4%. Previously, each payment was in equal amounts.

The Powerball FAQS/Contact Us page explains the reason for these changes:

"Each payment is 4% higher than the previous year's payment to help keep up with inflation. The annuity prize used to be paid out in equal payments. Persons who elect to take the annuity prize do so because they don�t want to worry about investing the money. They want to maintain their lifestyle for the term of the annuity. In fact, our past practice of equal installments did not really meet the needs of these winners."

Changing the jackpot annuity payment structure to meet the needs of the winners sounds like a noble cause, but since few winners have ever elected this type of payment, this change has not benefited many players.

Other Powerball Rules
In addition to the above annuity payment schedule, Powerball has defined several rules of play. To summerize:
  1. The Minimum Annuity Jackpot is $15 Million. Payments to players will never be lower than this amount.
  2. The Minimum Increase in the Annuity Jackpot between Drawings will be $5 Million.
  3. Payment of the Annuity Option will be delivered in 30 unequal installments, spread over a 29 year period.
  4. Each Annuity Payment will be 4% higher than the previous.
  5. Amounts of both the Cash and Annuity Options are Estimated Values Only. Actual payments may be higher or lower than stated (with the exception of the minimum $15 M)
  6. $0.30 of every ticket sold goes to the Jackpot pool.
  7. Player has 60 days to decide which option to take. (This is important)
  8. The method of payment is binding. Once a winner as chosen, the option cannot be reversed.


Powerball Annuity Yearly Cashflow Payments
Using the above information, we have constructed a cashflow diagram of a $15 million annuity. Graph GR0806b illustrates the 30 annuity payments that would be made to the winner of this $15 million regardless of interest rates. While Powerball says they estimate the annuity, we know that the minimum jackpot annuity payment is $15 million. Thus, these payments are fixed.


Note: This graph is for an $15 M annuity, but is scalable. If the annuity is $30 M, multiply payments by 2; if $75 M, multiply by 5; if $150 M, multiply by 10; etc.

The first payment is delivered immediately and those following increase by 4.0% each year. If we assume that the fair interest rate level was also 4.0% per year, then Powerball would need to create 30 buckets of $267 thousand each. The first $267,000 (rounded) would be paid to you when you were declared the winner, and all the rest would be invested in 4% annual paying interest Treasury Bonds or Strips. Looking at the above graph, the blue horizontal line illustrates the amount of money that was deposited. Everything above that line is interest earned. The total of all 30 payments, which include both the value of the cash deposited and the interest earned, will equal $15 Million (which is what you won).

But since Powerball only needs to allocate 30 $267 K buckets for payment, it only needs to aside $8.024 Million in order to make these payments (totaling $15 M) to you.

We shall define this value of $8.024 million as Par.
This has a Cash to Annuity ratio of 53.5%.



May 31 2008 Jackpot Revised
Adding the $8.024 M Par Value to our Jackpot Graph (GR0606c) provides us with a relative measure by which to judge the fairness of the $7.1 million cash option offering, which is $0.924 million below Par. In terms of ratios, we are offered 47.3% verses the par 53.5%, or a 5.2% loss.


Without knowing the prevailing interest rates by which to reinvest our Cash Option, we cannot yet say with certainty that the $7.1 offering is unfair.

But we know for sure that if we take the Annuity, $8.024 M will be set aside for our winnings. If we take the Cash Option, we immediately lose nearly $1.0 million. This comes out to losing $61.6 thousand per annuity million won.



Fair Value of Cash Option at Varying Interest Rates
Both the Powerball organization and us recognize that interest rates vary. Because of this, the value of the cash option will move in the opposite direction of interest rate movements. Thus, if interest rates go up, the cash option goes down, and vice-versa. Knowing the fair value of the cash option at various interest rate levels further will help us to judge the fairness of the Cash Option.


Graph GR0806d illustrates the fair value of the cash option value at interest rates varying from 2% to 10%. Note that when interest rates fall below 4%, the cash option increases above our $8.024 M Par Value (green line).

This graph tells us that when interest rates are at 2%, Powerball must invest $10.784 million to fund our $15 million annuity. At 3% interest, $9.262 must be deposited for funding. And, when interest rates rise to 10%, only $3.992 needs to be invested.

Referring to this graph, we observe that the May 31 2008 Cash Option of $7.1 M equates to an interest rate environment of slightly less than 5%. Considering that interest rates have fallen substantially during January 2008 and May 2008 (from 4.25% to 2.00%), this 5% level appears to be rather high.

Thus, the May 31 2008 $7.1 Million Cash Option begins to appear to be extremely low.

Note: The Cash Fair Value amounts in the graph are based on a $15 M annuity, but these are scalable. If the annuity is $30 M, multiply amounts by 2; if $75 M, multiply by 5; if $150 M, multiply by 10; etc.



Tax Implications
Regardless which option a winner selects, taxes represent a large portion of the income. Winners are automatically moved into the highest tax rates, and both standard and itemized deductions become limited.

For purposes of this analysis, we assume that Federal Taxes will consume 35% of one's winnings.

This means that for those who elect the $15 million Annuity Option, they will pay a total of $5.25 million to the IRS. Without paying State taxes (many states do not tax those residents who win Powerball),

Annuity winners keep $9.75 million

to spend and invest. One important benefit of taking the annuity is that taxes will only be paid on the amount of money given to the winner each year. All other interest being earned will remain and grow tax free until it is paid out later.

Conversely, those who decide to take the Cash Option will be taxed immediately. In the case of the May 31 2008 cash jackpot, the winner will fork over $2.5 million to the IRS. This means that the cash winner will only pocket $4.6 million. Typically, Powerball withholds only 25% of the jackpot winnings. This means that winners will be liable for the remaining 10% when they file their taxes. Most winners do not realize this and are unhappily shocked when they learn about the additional tax consequences.

The website USAMega.com provides excellent Powerball Jackpot Analysis pages that summarize both the Federal and State Tax implications on the Annuity and Cash Options.



Cash Value Implied Yield Curves
Knowing that $15 M annuity winners will retain $9.75 million of their winnings after taxes, it is possible to construct the associated Implied Yield Curves that will provide the cash option winners with the same amount of money. Using this $9.75 M value as a target, the Blue Curve displays the Tax Free Rates for varying cash offerings, meaning that the earned interest is not taxed until paid. Whereas, the Green Curve indicates the Taxable Equivalent Curve. The horizontal axis indicates the cash value offering in millions. The vertical axis indicates yield rates.


Note: These Cash Jackpot values are based on a $15 M annuity, and are scalable. If the annuity is $30 M, divide the offered amount by 2; if $75 M, divide by 5; if $150 M, divide by 10; etc.

Returning to the May 31 2008 drawing, the Cash Jackpot offering is $7.1 million.

Assuming that this is the fair value, it will be the same amount that Powerball will invest for the Annuity winners. From the graph GR0806e Blue Curve, we can guesstimate that Powerball will invest this money at approximately 4.8%. The interest earned on the annual payments will compound tax free at this rate and will generate a total of $15 M in payments to the winner. After taxes, the player will get to keep the $9.75 million.

However, if the player selects the cash option, he will receive $7.1 million, pay $2.5 M in taxes, and invest the remaining $4.6 million. The Green Curve in graph GR0806e already takes the reduction of taxes into account. So, to find the taxable equivalent yield the player must earn, we locate $7.1 M on the horizontal axis, then find the point on the Green Line above it. Doing this, we find that the cash option winner must receive approximately 6.2% on the remaining $4.6 M in order to earn $9.75 million.



Evaluating the May 31 2008 Cash Offering
Considering the Federal Reserve has reduced interest rates substantially, we know that short term rates are around 2-3%, 10-year treasuries less than 4.1%, and 30-year treasuries below 4.7%. Thus, it is impossible for Powerball to earn an average rate of 4.8% on the annuity deposit at this time. Therefore, we conclude that:

The $7.1 million cash offering is extremely undervalued,
and should be at least $8 or more million.



Cash Loss per Million (Jan 2 - Jun 18 2008)
To test the correlation of the Cash Option Jackpot offering against actual changes in interest rates, we have constructed the Cash Loss per Annuity Million graph at right.


We define Cash Loss as the difference between the expected Cash Par Value and the Offered Cash Value, normalized to a single $1.0 million in annuity value.

As shown, the graph covered the 49 drawings beginning January 2 2008 and ending June 18 2008. The magnitude of the loss is displayed on the y-axis, and ranges from -$10,000 to -$60,000 per annuity equivalent million dollars. The vertical Green Lines indicate when a Powerball Jackpot was won, and was reset to the minimum $15 M. The horizontal Blue Line indicates the average loss of $40,000 per million.

During this period, the FOMC reduced the Federal Funds Target rate:
  • Jan 22 2008 - from 4.25% to 3.50%
  • Jan 30 2008 - from 3.50% to 3.00%
  • Mar 18 2008 - from 3.00% to 2.25%, and
  • Apr 30 2008 - from 2.25% to 2.00%.
These are indicated by the magenta dots on the graph.

Because the interest rates were lowered, we would expect the Ratio of the Cash Offered Jackpot to Annuity to the closer to the Par Jackpot ratio of 53.5%, thus bringing the Loss per Million closer to zero.

But in reality, the Cash offering by Powerball appears to be random. During the period January 30 and March 18 when Fed Funds was 3.00%, the loss became larger, and then smaller. After the March 18 cut, the loss narrowed, as expected. After the last lowering to 2.00% on April 30, the loss widened to a high of $60,000 per annuity million.

Since players and winners had no basis to evaluate the fairness of the cash prize offering, complete trust was placed in the Powerball estimate, which appears to be arbitrary.

Returning to our May 31 2008 example, we observe that the Jackpot Loss on that date was at its largest. Knowing that the interest rates had declined, we would have expected that the Cash Offering to increase. Because it decreased, we further believe that the:

Annuity Offer is Better!



Summary
To summarize, winners who elect to receive the Cash Option are usually penalized because: the Cash Option Value is under estimated; interest rates are typically lower than that offered by the Annuity; and, taxes erode the both the cash payment and interest earned.

Sample chart
To visualize the May 31 2008 Cash Offering payout, Graph GR0806g illustrates the Cash breakdown against the comparitive $15 million annuity prize. The player will retain a total of $7.9 million in winnings, consisting of the $4.6 M cash payment and $3.3 M of interest earned. A total of $4.3 million will be paid in taxes. And, $2.8 million will lost to Powerball.

Conversely, winners who elect to receive the Annuity payments will retain $9.75 million in cash, and will pay $5.25 million in taxes.

Sample chart
The net difference in money retained by the winner will be $1.85 million spread over the 30 payments.

This equates to approximately $61.7 thousand dollars per year. This is a lot of money.

Note: All amounts shown are based on a $15 M annuity at 4% interest. These values are scalable. Thus, if the annuity is $30 M, multiply amounts by 2; if $75 M, multiply by 5; if $150 M, multiply by 10; etc.



Conclusion
In this discussion, we have: illustrated how the Annuity payments are made; identified the fair cash value Par value or $8.024 million; described the fair cash jackpot offerings at varying interest rates; created the non-taxable and taxable implied break-even yield curves; shown the historical cash loss per million; and summarized the breakdowns of money retained, taxes paid, and money lost.

By focusing on the May 31 2008 cash and annuity jackpot offerings of $7.1 M and $15 M, we have concluded that winners in this drawing are far better off by receiving the Annuity Payments instead of the Cash Option.

Lastly, our advice with regard to this Powerball drawing (and most likely others) is to:

Take the Annuity,
You'll have alot More Money.



Learn More
We have not found many sites that provide detailed Powerball Jackpot information. However, you can learn more by visiting the following:
Focus for August: Analysis of the Mega Millions Jackpot



StumbleUpon Toolbar Stumble It!