Question

You are presented with an investment opportunity that returns 25% per annum for the next 15 years. You expect inflation to average 10% per annum over the investment horizon. Calculate:

a) In nominal terms, what would be the terminal value of $00/- invested in this opportunity?

b) In real terms, what would be the terminal value of $10/- invested in this opportunity?

i = (1+i*) (1+p) – 1

i* = (1+i)/ (1+p) - 1

i = nominal interest rate

i*= (required) real interest rate

p = expected inflation rate

Answer 1

Nominal interest rate (i*)= 25%

Expected inflation (p)= 10%

Real interest rate (i) = ??

i* = (1+i) / (1+p) - 1

So

i* = 1.25 / 1.10 -1

i* = 13.63%

a)

Maturity = 15 years

Nominal rate = 25%

Amount to be invested = $10

Terminal value = amount invested * (1+nominal rate)^n

Terminal value = 10*(1.25)^15

Terminal value = 284.22

b)

Maturity = 15 years

Nominal rate = 13.63%

Amount to be invested = $10

Terminal value = amount invested * (1+nominal rate)^n

Terminal value = 10*(1.1363)^15

Terminal value = 67.98

answered by: anonymous