Submission Requirements: Answer each problem in detail with a conclusion and res

Question

Submission Requirements:
Answer each problem in detail with a conclusion and results.
Submit your answer in a Microsoft Excel file, showing step-by-step solutions to all calculations.

Question: You are planning to invest $2,500 today for three years at a nominal interest rate of 9 percent with annual compounding. a. What would be the future value of your investment? Answer: b. Now assume that inflation is expected to be 3 percent per year over the same three-year period. What would be the investment’s future value in terms of purchasing power? Answer: c. What would be the investment’s future value in terms of purchasing power if inflation occurs at a 9 percent annual rate? Answer:

Submission Requirements:
Answer each problem in detail with a conclusion and results.
Submit your answer in a Microsoft Excel file, showing step-by-step solutions to all calculations.

Explanation / Answer

a)

Future Value of $2,500 invested today for 3 years at 9% with annual compunding will be

             = 2500 * 1.093 = $3237.57

b) Inflation = 3% and Nominal Interest Rate = 9%

To calculate the investment's future value in terms of purchasing power, we will have to find out the real interest rate.

(1 + Real Interest Rate)(1 + Inflation) = (1 + Nominal Rate)

Real Interest Rate = (1 + Nominal Rate)/(1 + Inflation) - 1

                             = (1 + 9%) /(1 + 3%) - 1

                             = 1.09/1.03 -1 = 5.8252%

Investment’s future value in terms of purchasing power = 2500 * (1 + 5.8252%)3 = $2962.84

c) Inflation = 9% and Nominal Interest Rate = 9%

(1 + Real Interest Rate)(1 + Inflation) = (1 + Nominal Rate)

Real Interest Rate = (1 + Nominal Rate)/(1 + Inflation) - 1

                             = (1 + 9%) /(1 + 9%) - 1

                             = 1.09/1.09 -1 = 0%

Investment’s future value in terms of purchasing power = 2500 * (1 + 0%)3 = $2500

Part Investment Amount Nominal Interest Rate Period(Years) Future Value a) 2500 9% 3 3237.57 Part Investment Amount Nominal Interest Rate Inflation Real Interest Rate Period(Years) Future Value in Terms of Purchasing power b) 2500 9% 3% 5.8252% 3 2962.84 Part Investment Amount Nominal Interest Rate Inflation Real Interest Rate Period(Years) Future Value in Terms of Purchasing power c) 2500 9% 9% 0.0000% 3 2500.00

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