over the next three years (a ) Determine the annual infilation-free interest rat
ID: 2805248 • Letter: O
Question
over the next three years (a ) Determine the annual infilation-free interest rate ("') for the bank (b) What equal monthly payments, in terms of constant dollars over the next three years, to be made over life of the loan? On her 23rd birthday, an engineer decides to start saving toward building up a retirement fund that pays 9% interest compounded quarterly (market interest rate). She feels that $800.000 worth of purchasing power in constant dollars will be adequate to see her after retirement at 63rd birthday. Assume an average inflation rate of 5% per year. (a) If she plans to save by making 160 equal quarterly deposits, what should be the amount of each quarterly deposit in actual dollars? (b) If she plans to save by making end-of-the-year deposits, how much wo her first deposit be in constant dollars?Explanation / Answer
Solution:
Real rate = Nominal rate – Inflation
Real rate = 9% - 5% = 4%
PV = $800,000
a. I = 2%/4 = 0.5%
PV = A (PVIFA @ 0.5%, 160)
800,000 = A [(1.005^160-1)/(0.005*1.005^160)]
800,000 = A (109.9549)
A = $7,725.71
b. PV = A (PVIFA @ 2%, 40)
800,000 = A [(1.02^40-1)/(0.02*1.02^40)]
800,000 = A (27.35548)
A = $29,244.60
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