Wednesday, October 13, 2010

Quiz 2, Question 2 for 1:10 Section

When I graded question 2, I primarily looked for the following:

1) Did you calculate the inflation rate
2) Did you find the real interest rate
3) Did you use the real interest rate (instead of the nominal rate) to find your return.

There is a second approach to the problem. You could find the nominal return which is 1000*(1.08)^3 = 1259.71 or a 25.9% return.

The next step is to find the rate the price level increased. This is done by taking the price level multiplied by the inflation rate.

Year 1: 100*(1.06) = 106
Year 2: 106*(1.075) = 114
Year 3: 114*(1.035) = 118

This means that prices have increased from 100 to 118 or an 18% increase. Then you can calculate your return 25.9% - 18% = 7.9%.

If you did this please bring your quiz on Wednesday.

1 comment:

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