A bank account currently pays interest at a rate of 3% per year. The current inf

ID: 1227354 • Letter: A

Question

A bank account currently pays interest at a rate of 3% per year. The current inflation rate is 2%

per year.

a) (8 points) If I invest some money in the bank account, then what is the real interest rate that I am earning?

b) (10 points) I open a new account today, deposit $10,000, and do not expect to make any deposits or

withdrawals for the next two years. What will be my account balance at the end of two years expressed in

Then-current dollars

Constant dollars

c) (2 points) If I decide to withdraw the entire balance in my account and close the account at the end of the

two-year period, how much money will I actually get in my hand?

Please Do Not Use Excel!!!

According to ques,

Interest rate paid on deposit is 3% per year and current rate of inflation is 2%.

A) The real interest rate is given by the formula,

nominal interest rate=real interest rate + inflation rate

3% =real interest rate + 2%

real interest rate is 1%.

B) If $10,000 are deposited today for next 2 years then the value at the end of the year is given by,

First we calculate the FV ( FUTURE VALUE) of the deposit which is given by,

FV=P(1+r)^n

=10000(1+0.03)^2

=10609

Now PRESENT VALUE of the deposit is given by

PV=FV/(1+r)^n

=10609/(1+0.03)^2

=10609/1.0609

=10,000

Thus, the current dollars value is given by $10,000.

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