I was able to answer (a, b, & c), but I\'m unable to figure out questions (d & e

Question

I was able to answer (a, b, & c), but I'm unable to figure out questions (d & e).

Zane Perelli currently has $100 that he can spend today on polo shirts costing $25 each. Alternatively, he could invest the $100 in a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of interest. The consensus forecast of leading economists is a 5% rate of inflation over the coming year.

a. How many polo shirts can Zane purchase today? $100/25 = 4

b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today? = $100 + (1+0.09)1 = $100.00 + 9.00 = $109.00

c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation? = (0.05 x $25.00) = $26.25

d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage, how many more or fewer polo shirts can Zane buy at the end of 1 year?

e. What is Zane’s real rate of return over the year? How is it related to the percentage change in Zane’s buying power found in part d? Explain.

Explanation / Answer

d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage, how many more or fewer polo shirts can Zane buy at the end of 1 year?

No of polo shirts Zane can purchase = 109/26.25

No of polo shirts Zane can purchase = 4.1524

In percentage ,No of more polo shirts can Zane buy at the end of 1 year = (4.1524-4)/4

In percentage ,No of more polo shirts can Zane buy at the end of 1 year = 3.81%

e. What is Zane’s real rate of return over the year? How is it related to the percentage change in Zane’s buying power found in part d? Explain.

Zane’s real rate of return over the year = (1+nominal Rate)/(1+inflation rate) -1

Zane’s real rate of return over the year = (1+ 9%)/(1+5%) - 1

Zane’s real rate of return over the year = 3.81%

it is related to the percentage change in Zane’s buying power found in part d because in part d it is increased in proportion of real rate of return as nominal rate is being increased with proportion of inflation increase , net increase is the real rate of return

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