2. You buy a one-year debt security on December 31, 2016, for $10,000, which wil

Question

2. You buy a one-year debt security on December 31, 2016, for $10,000, which will pay you a nominal interest rate of 5%. From December 31, 2016, to December 31, 2017, the inflation rate is 2%. You have a tax rate of 35%. Answer the following and show your calculations. a) How much nominal interest do you earn during the year? b) How much do you pay in taxes on your interest income? c) How much is your after-tax nominal income? d) How much principal do you lose because of inflation? e) How much real interest income do you earn? f) How much is your after-tax real interest income? g) What percent of your nominal interest income goes to: (1) you, in the form of after-tax real interest income (2) the government, in the form of taxes (3) inflation, in the form of lost principal value

Explanation / Answer

As per rules I will answer the first 4 sub parts of the question

a: Amount of nominal interest =Rate*Amount of debt security

= 5%*10,000 = $500

b: Tax = Tax rate * Interest

= 35%* $500

= $175

c: After tax nominal interest = Interest - Tax

= 500 -175

=$325

d: Amount of principal lost due to inflation = Inflation rate * Principal amount

= 2%*10,000 = $200

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