Question: You are planning to invest $2,500 today for three years at a nominal i

Question

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: 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:

Explanation / Answer

Solution-a

$2,500(1.09)3 = $3,237.57

Solution-b

9%-3% = 6%
In terms of purchasing power, the future value would be $2,500(1.06)3 = $2,977.54

Solution-c

If inflation is 9 percent annual rate, then it is the same as the interest rate. That means the purchasing power is the same. The purchasing power of $2,500 is the same over time

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