Suppose expectations are such that the rate of inflation for the foreseeable fut
ID: 1219545 • Letter: S
Question
Suppose expectations are such that the rate of inflation for the foreseeable future is pegged at 2%. Further suppose that lenders and investors are seeking a 4% real return. 37. Money will be lent at what rate of interest under this scenario? A. 2% B. 8% C. 4% D. 6% E. Impossible to determine.
38. Suppose that 4 years from now it is obvious that the actual rate of inflation averaged 1%. Which of the following statements is correct regarding loans initially granted with 4-year terms? A. Both lenders and borrowers meet their objectives. B. There is an arbitrary redistribution of income from lenders to borrowers. C. There is no redistribution of income resulting from the loans. D. There is an arbitrary redistribution of income from borrowers to lenders.
39. Suppose that I have $1,000,000 in my current retirement portfolio. Further suppose that the dollar value of my portfolio must double for me to retire comfortably. Assuming that I make no further contributions to my portfolio, how long must I wait,? A. 17.5 years B. 35 years C. approximately 18 years D. None of the above
40. Again, assuming that I make no further contributions to my portfolio, how long must I wait if I need the value of my portfolio to double in terms of real dollars? A. 17.5 years B. 14 years C. approximately 8 years D. impossible to determine
Explanation / Answer
37) Nominal interest rate = Real interest rate + Inflation
Here real rate is 4% and inflation is 2% so the lowest possible lending rate is 6%.
38) Average inflation rate is mentioned as 1% after 4 years.
Now if it is decreased than current rate then lender is has gained and borrower has transferred his income to lender as real return have increased.
On the other hand if inflation has increased from the previous rate then lender has seen his real return decreased and redistributed his income to borrower.
39) We will have to find out time period with future value of 200,000 and nominal interest rate of 6%
With rule of 72 when we divide 72 by interest rate to get approximate duration to double the income, it will be roghly 12 years. It is not mentioned in the options so none of the above.
40) In real terms to get double the income we will have to take the real rate of return in the calculation.
Again using rule of 72, we get 18 years roughly. So we can guess that it will be needed 17.5 years to double the income in real terms.