Question

a. The historical average rate of inflation in the United States is 4%. If you bury $770. What will the buying power of that money be in todays dollars in 17 years? $ _____

b. For a particular year the inflation rate was 3.19%. What was the real interest rate of return on a CD that payed 8.34% for that year? _____ %

You have $32780 to invest for retirement. You expect to retire in 50 years. A particular index fund has a long history of paying 7.47%, and inflation is estimated to be 3.1%.
c) If you invest in that fund what would you expect your actual saving to be when you retire? $ _____
d) What will your real value be at the time you retire? $ _____

Answer 1

Solution :

Part A )

Inflation = 4%, Amount today = 770, Years = 17

Due to inflation every year value will be discounted by 4%

So value after 17 years = 770 / (1+0.04)^17 = $395.23

Part B )

Inflation = 3.19%, Return on CD = 8.34%

We know that Real return = Nominal return - inflation

So real return on CD = 8.34% - 3.19% = 5.15%

Part C )

Investment = $32,780 and return on the investment = 7.47% while inflation is 3.1%

So Amount after 50 Years or nominal return = P * (1+i)^years = 32,780 * (1+0.0747)^50 = 1,202,185.24

Part D )

Since there is inflation of 3.1% so real interest rate = Nominal - inflation = 7.47% -3.10% = 4.37%

Real Value = 32,780 * (1+0.0437)^50 = 278,223.06