Assume that the inflation rates observed over the last 10 years are as follows:

Question

Assume that the inflation rates observed over the last 10 years are as follows: 3% over the first 2 years, 6% over the next 5 years and 4% over the next 3 years. What is the average inflation rate over the 10 year period? I. You put $500 in a savings account in a bank that pays 6% annual interest rate. You withdrew the money after 3 years. The average inflation rate over this period was 3%. Prepare a table to show the inflation adjusted cash flow. Ignore the issues related to income tax. 2. You purchased a bond for $10,000 and kept it for 5 years when it matures. The bond pays $500 in dividend per year. The average inflation during this period is 2% per year. Prepare a table to show the inflation adjusted cash flow. Include the income tax in this table. Assume that you are already in the 28% income tax bracket. 3.

Explanation / Answer

Q1

Answer

average rate={(1+i1)^n1 *(1+i2)^n2 *(1+i3)^n3}^(1/N)-1

where

N=n1+n2+n3

i1 is first infaltion rate for time of n1 period and so on

average inflation rate=(1.03^2 *1.06^5 *1.04^3)^(0.1)-1

=1.04792543-1

=0.04792543

=4.79%

the average inflation rate is 4.79%

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