2) (20 points) A local credit union pays intrest at a rate of 5% per year for lo

Question

2) (20 points) A local credit union pays intrest at a rate of 5% per year for long-term deposits. The current inflation rate is 2% per year. a) (8 points) If I invest some money in a long-term fund at the credit union, what is the real (inflation-free) interest rate I will be carning? b) (10 points) I open a new account today, deposit $10,000, and do not expect to make any deposits or withdrawals for the next two years. What will be my account balance at the end of two years expressed in Then-current dollars c) (2 points) If I decide to withdraw the entire balance in my account and close the account at the end of the two-year period, how much money will I actually get in my hand?

Explanation / Answer

2.

A

Real interest rate = nominal interest rate – inflation rate = 5%-2%

Real interest rate = 3%

B.

At current dollars:

Balance in account in 2 years = Deposit* (1+ interest Rate)^n = 10000*(1+5%)^2

Balance in account in 2 years = $11025

At Constant dollars:

Balance in account in 2 years = Deposit* (1+ interest Rate)^n/(1+inflation rate)^n

Balance in account in 2 years = 10000*(1+5%)^2/(1+2%)^2

Balance in account in 2 years = $10596.89

C.

After 2 years, I will get paid the amount of $11025.

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