Log in
Finance
1
answer
0
watching
87
views

You would like to invest $15,000 for a year in a risk-free investment. A conventional certificate of deposit (CD) offers a 5.2% annual rate of return. You are also considering an “Inflation-Plus” CD which offers a real rate of return of 2.4% regardless of the inflation rate.


a. What is the implied (expected) inflation rate? (Round your answer to 2 decimal places.)


Implied inflation rate %


b.

You decide to invest $7,500 in the conventional and $7,500 in the “Inflation-Plus” CD. What is your expected dollar value at the end of the year?


Expected value $


c. Which of the two CDs is a better investment if the actual inflation rate for the year turns out to be 2.4%?
Inflation-Plus CD turns out to be a better investment.
Conventional CD turns out to be a better investment.

Watch
1
answer
0
watching
87
views

For unlimited access to Homework Help, a Homework+ subscription is required.

Bunny Greenfelder
Bunny GreenfelderLv2
28 Sep 2019

Unlock all answers

Get 1 free homework help answer.
Already have an account? Log in
Share

Related questions

Each possible investment is perceived to have no risk of default. You plan to maintain this investment for a one-year period. The return of each investment over a one-year horizon will be about the same if interest rates do not change over the next year. However, you anticipate that the U.S. inflation rate will decline substantially over the next year, while most of the other portfolio managers in the United States expect inflation to increase slightly. a. If your expectations are correct, how will the return of each investment be affected over the one-year horizon? b. If your expectations are correct, which of the three investments should have the highest return over the one-year horizon and why? Offer possible reasons you might not select the investment that would have the highest expected return over the one-year investment horizon.

As a portfolio manager for an insurance company, you are about to invest funds in one of three possible investments: a) 10-year coupon bonds issued by the U.S. Treasury, b) 20-year zero-coupon bonds issued by the Treasury, or c)One-year Treasury securities. Each possible investment is perceived to have no risk of default. You plan to maintain this investment for a one-year period. The return of each investment over a one-year horizon will be about the same if interest rates do not change over the next year. However, you anticipate that the U.S. inflation rate will decline substantially over the next year, while most of the other portfolio managers in the United States expect inflation to increase slightly.

a. If your expectations are correct, how will the return of each investment be affected over the one-year horizon?

b. If your expectations are correct, which of the three investments should have the highest return over the one-year horizon and why?

C. Offer possible reasons you might not select the investment that would have the highest expected return over the one-year investment horizon.

Are my answers correct?

Suppose you invest $10,000 in a savings account earning 2% interest (compounded yearly) with no risk. After 7 years, how much will you have?

Principal = $10,000.00

Rate = 2.00%

Year = 7

Amount (Compound interest) = P x (1 + r/n) ^nt

Where P = Principal

r rate of interest

n = number of time interest is calculated in a year

t = time

Amount after 7 years = 10,000 x (1+0.02) ^7 = $11,486.86

Repeat Question #1, but this time there is an inflation rate of 4%. How does this change your overall return on investment? If you had a chance to invest in an account with a long-term expected rate of 5%, with a 50% chance of earning 0% nominal compound interest and a 50% chance of earning 10% nominal compound interest in each year, would you choose this account, or the savings account? Why?

Effects of inflation on PV = 10,000 x (1/(1+0.04)^7) = $7,599.18

FV Adjusted for inflation = 11,486.86 x (1/(1+0.04)^7) = $ 8,729.07

Overall return on investment will decrease by 1,270.93 = 10,000 – 8,729.07

Repeat #1 with inflation:

Amount after 7 years = 10,000 x ((1+0.02)/(1+0.04)) ^7

10,000 x (0.98) ^7 = $8,729.07.

Safe vs. Risky (not including inflation)

If I get 0%, the amount after 7 years = 10,000 x (1+0.00) ^7 = $10,000.00

If I get 10%, the amount after 7 years = 10,000 x (1+0.10) ^7 = $19,487.17

If I get 5% (expected), amount after 7 years = 10,000 x (1+0.05) ^7 = $14,071.00

I would choose the account with the 5% expected rate of return because it has higher effective annual return over the saving account. There is a higher return, but the risk is higher as compared to the savings account, which provides a certain return.

Suppose you will need $50,000 in 4 years to start up a new business you have planned. With a 5% real interest rate, how much do you have to invest now in order to achieve this goal?

This condition clearly says that we need to calculate the present value of the future earnings and it has to be the present value factor and not annuity.

Therefore, to get 50000 is the future value therefore present value of 50000

Amount to be invested today =PVF@5%,4 *Amount

= .82270 * 50000

= $ 41135.12

Repeat Problem #3, but assume you can contribute an equal amount on a yearly basis. How much would you need to put into the account each year?

Amount to invested each year = Amount /FVAF@5%,4 = 11,600.66

Weekly leaderboard

Home
Homework Help 3,900,000
Finance 370,000
Start filling in the gaps now
Log in