In order to receive jull credit, you must show your work on your paper. 9. You d
ID: 1159209 • Letter: I
Question
In order to receive jull credit, you must show your work on your paper. 9. You deposit $5,000 in the bank for one year. Assume the tax rate is 10%. CASE 1: inflation rate 5% nominal interest rate-12% CASE 2: inflation rate: 6%, nominal interest rate-896 a. How much tax do you pay in Case 1? b. How much tax do you pay in Case 2? c. Compute the after-tax real interest rate for Case d. Compute the after-tax real interest rate for Case 2 e. In which case would you earn the highest real return after tax?Explanation / Answer
Question c.
Nominal interest rate = 12%
Tax rate = 10%
After tax nominal interest rate= 12 - 10% of 12 = 12 - 1.2= 10.8%
Real interest rate = Nominal interest rate - inflation rate
After tax real interest rate = After tax nominal interest rate - inflation rate = 10.8 - 5= 5.8%
Question d.
Nominal interest rate= 8%
Tax rate= 10%
Inflation rate = 6%
After tax nominal interest rate= 8 - 10% of 8= 7.2%
Real interest rate= Nominal interest rate - inflation rate
After tax real interest rate= After tax nominal interest rate - inflation rate= 7.2 - 6= 1.2%
Question e.
Case 1: Inflation rate = 5% and Nominal interest rate = 12 %
Case 2: Inflation rate = 6% and Nominal interest rate = 8%
Now for Case 1,
Amount= 5000
Nominal interest rate = 12%
Tax rate = 10%
Nominal interest rate after tax = 12 - 10% of 12 = 12 - 1.2 =10.8%
Inflation rate = 5%
Real interest rate = Nominal interest rate - inflation rate
After tax real interest rate = After tax nominal interest rate - inflation rate = 10.8 - 5= 5.8%
After tax real return = After tax real return x Amount = 5.8% of 5000= 5.8/100 X( 5000)= $290
Case 2:,
Amount = 5000
Nominal interest rate= 8%
Tax rate= 10%
Inflation rate = 6%
After tax nominal interest rate= 8 - 10% of 8= 7.2%
Real interest rate= Nominal interest rate - inflation rate
After tax real interest rate= After tax nominal interest rate - inflation rate= 7.2 - 6= 1.2%
After tax real return = After tax real interest rate x Amount = 1.2% of 5000= 1.2/100 x 5000= $60
Answer: You would earn the highest real return after tax in Case I which is $290.