Do not use excel. Only use hand written formulas, and a BAII plus financial calc

Question

Do not use excel. Only use hand written formulas, and a BAII plus financial calculator for calculations. Please explain every step in detail.

Problem 9 2-year inflation-protected loan of 20,000 specifies an annual effective interest rate of 3.5% and level annual repayments (before adjustments for inflation). At times 0, 1, and 2, the price index specified in the loan agreement has the values shown in the following table Time (years since 02 loan origination) Index 194.7 199.8 203.6 Calculate the amounts of the loan payments at the end of the first and second year of the loan.

Explanation / Answer

In an inflation-protected loan, the principal will be adjusted according to inflation and the interest payable is calculated on the new principal outstanding.

Original Principal =$20,000

Original Interest Rate =3.50%

Initial Index Value =194.70

Index after 1 year = 199.80 => Inflation in Year-1 = 199.80/194.70 - 1 = 0.0262 or +2.62%

Index after 2 year = 203.60 => Inflation in Year-2 = 203.60/199.80 - 1 = 0.0190 or +1.90%

Level Annual Payment before Inflation Adjustment =PMT (0.035, 2, 20000) =$10,528

Amount Payable at the end of first year after inflation adjustment =$10,528 x 1.0262 =$10,804

Loan Balance at the end of first year =$10,528 - 0.035*20000 =$10,528 -700 =$10,172

Adjusting outstanding balance to inflation =$10,172x1.0262 =$10,438

Amount Payable at the end of second year after inflation adjustment =$10,804 x 1.0190 =$11,009

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