Question 14.8: If general price inflation is estimated to be 5% for the nex...
If general price inflation is estimated to be 5% for the next five years, 7. 5% for the three years after that, and 3% the following five years, at what market interest rate (i) would you have to invest your money to maintain a real purchasing power growth rate (i′) of 10% during those years?
In Years 1-5 you must invest at 0.10 + 0.050 + (0.10)(0.050) = 0.1550 = 15.50% per year.
In Years 6-8 you must invest at 0.10 + 0.075 + (0.10)(0.075) = 0.1825 = 18.25% per year.
In Years 9-13 you must invest at 0.10 + 0.030 + (0.10)(0.030) = 0.1330 = 13.30% per year.
(Note: Most interest-bearing investments have fixed, up-front rates that the investor understands well when making an investment. On the other hand, inflation is not quantified, and its effect on our real return is not measured until the end of the year. Therefore, the real investment return (i′) may not turn out to be what was originally required.)