Question

Assumptions:

• Invest $4,500 now
• Earn 6% per year, simple compounding
• Inflation is 3.5% per year.

Questions:

1. Determine the nominal and real values of your investment after 5 years.

b.Determine the real rate of return, in total and per year.

Answer 1

a. The earnings is 6% p.a. and the inflation is 3.5% p.a.

So, Nominal Rate = Real Rate - Inflation Rate = 6% - 3.5% = 2.5%

Nominal Value after 5 Years = P(1+ RT) = 4,500 ( 1 + (2.5%)(5)) = $5,062.5

Real Value after 5 Year = P(1+ RT) = 4,500 ( 1 + (6%)(5)) = $5,850

b. The real rate of return per year is 2.5%

The Total Real Return on Investment = (5,062.5 - 4,500) / (4,500) = 12.5%

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