Question

# A) After a 1 year investment you receive 7% interest (nominal) from your bank. However, looking...

A) After a 1 year investment you receive 7% interest (nominal) from your bank. However, looking at how prices have changed, you soon realize that the real rate of interest was actually 1.9%. How much was inflation during that year?

B) You are offered a court settlement in the following terms: you will receive 7 equal payments of \$4,185 each every year, with the first payment being made 2 years from now. The current annual interest rate is 5%. Assume yearly compounding. What is this settlement worth in present value terms?

A) We know that

Real Rate of interest = Nominal Rate of interest - inflation rate

Given Nominal Rate of interest = 7%

Real Rate of interest = 1.9%

1.9% = 7% - Inflation Rate

Inflation Rate = 7% - 1.9%

Therefore Inflation rate is 5.1%

B) Computation of Present Value

 Year Amount Discount rate@ 5% Discounting Factor Discounted Cash flows 2 \$4,185 1/( 1.05)^2 0.9070 \$3,795.92 3 \$4,185 1/( 1.05)^3 0.8638 \$3,615.16 4 \$4,185 1/( 1.05)^4 0.8227 \$3,443.01 5 \$4,185 1/( 1.05)^5 0.7835 \$3,279.06 6 \$4,185 1/( 1.05)^6 0.7462 \$3,122.91 7 \$4,185 1/( 1.05)^7 0.7107 \$2,974.20 8 \$4,185 1/( 1.05)^8 0.6768 \$2,832.57 Total \$23,062.83

Therefore the Present value of Settlement is \$ 23062.83 .

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