On January 1, 2012, Albert invested $1,000 at 6 percent interest per year for th

Question

On January 1, 2012, Albert invested $1,000 at 6 percent interest per year for three years. The CPI (times 100) on January 1, 2012, stood at 100. On January 1, 2013, the CPI was 105; on January 1, 2014, it was 110; and on January 1, 2015, the day Albert’s investment matured, the CPI was 118. Find the real rate of interest earned by Albert in each of the three years and his total real return over the three-year period. Assume that interest earnings are reinvested each year and themselves earn interest.

Hint: Calculate inflation and real interest for each year and then calculate it for the three years as a whole.

Instructions: Enter your responses rounded to one decimal place. If you are entering any negative numbers be sure to include a negative sign (-) in front of those numbers.

Total real rate of return: %.

Explanation / Answer

At every year end:

2012: Inflation = (105 / 100) - 1 = 5%

Real interest rate = Nominal interest rate - inflation rate = 6% - 5% = 1%

2013: Inflation = (110 / 105) - 1 = 4.76%

Real interest rate = 6% - 4.76% = 1.24%

2014: Inflation = (118 / 110) - 1 = 7.27%

Real interest rate = 6% - 7.27% = - 1.27%

Total real rate of return = [(1.01) x (1.0124) x (0.9873)]1/3 - 1

= 0.3169%

Related Questions

Navigate

• Browse (All)
• Browse O
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.