Chapter 3, Section 2 - Purdue University



Chapter 1, Section 14

1. The inflation adjusted interest rate is 6% given an inflation rate of 8%. Calculate the nominal interest rate.

2. The nominal interest rate is 6%. The expected inflation rate is 8%. Calculate the real rate of interest.

3. The nominal interest rate is 10.25%. The rate of inflation and the real rate of interest are equal. Calculate the rate of inflation.

4. Today you have enough money to buy 100 bags of M&M’s.

Inflation over the next four years is expected to be 4% per year compounded annually. If you invest your money over the next four years, you can earn 8% compounded continuously.

Assuming you invest your money instead of buying 100 bags of M&M’s, how many bags of M&M’s can you buy at the end of four years?

Chapter 2, Section 2

5. Question 1 in the Book

6. Question 2 in the Book

7. Question 3 in the Book

8. Question 4 in the Book

9. Melvin invests 1000 in a bank account earning a constant annual effective interest rate. Using the Rule of 72, Melvin estimates that he will have 2000 in 10 years.

How much will Melvin actually have in 10 years?

10. Jennifer invests 1000 in a fund earning an annual effective interest rate of 10%. She wants to know when she will have 4000. Her banker estimates the time using the Rule of 72 as X years. Jennifer calculates it exactly as Y years. X and Y are not necessarily integers.

Calculate Y - X.

Chapter 2, Section 3

11. Question 1 in the Book

12. Question 2 in the Book

13. Question 3 in the Book Hint: Find Anne’s effective interest rate for T years using the cash flow and IRR functionality of your calculator. Then T can be found by (1 + IRR) = (1.06)T. Make sure you understand why this is true.

14. Question 4 in the Book. Hint: Find the quarterly effective interest rate and then use our relationship formula to find the annual effective rate of interest.

15. Question 5 in the Book.

16. Question 6 in the Book. Hint: Find Anne’s effective annual interest using the cash flow and IRR functionality of your calculator. Put in 0 (zero) for the cash flows at time 1 and 3. Use this interest rate to determine when Frank should make his payment.

Chapter 2, Section 4

17. Question 4 in the Book

18. Question 8 in the Book. Hint: Find the quarterly effective interest rate and then use our relationship formula to find the annual effective rate of interest

19. Trey, Lisa and Emily enter into a financial arrangement. Under the arrangement, Trey will pay 5000 to Lisa today. Trey will also pay 10,000 to Emily today. At the end of one year, Emily pays 11,000 to Lisa. At the end of three years, Lisa will pay a total of 18,000 to Trey.

Using the bottom line approach, calculate the annual effective interest rate for Trey.

20. Kyle has agreed to pay Aaron 1000 now. In two years, Aaron will pay Andrew a payment of 600. At the end of four years Aaron will pay Kyle a payment of 700. Also, at the end of four years, Andrew will make a payment of 800 to Kyle plus a payment of 100 to Aaron.

Using the bottom line approach, what is Kyle’s annual return on this transaction?

Chapter 2, Section 5

21. Kelli loans 2000 to Adam today. Adam repays the loan by making two payments: One payment of 1500 at the end of two years and a second payment of 1200 at the end of four years.

a. Calculate the interest rate on this loan from Adam’s standpoint.

b. Calculate Kelli’s return on the loan assuming her reinvestment rate on the loan payment at the end of two years is 7%.

c. Calculate Kelli’s return on the loan assuming her reinvestment rate on the loan payment at the end of two years is 14%.

22. Claire loans 20,000 to Jim. Jim repays the loan with two payments of 12,000. One payment is made at the end of one year and the second payment is made at the end of two years. Claire reinvests the payment at time 1 at a reinvestment rate of i. Claire’s annual yield is 12%.

Calculate i.

Chapter 2, Section 6

Use the following information about an investment fund for problems 23 – 25:

|Time |Fund Value Before Contributions |Contributions |

|0 |10,000 |0 |

|¼ |8,000 |-3,000 |

|½ |8,000 |3,000 |

|¾ |12,000 |3,000 |

|1 |15,000 |0 |

23. Calculate the exact annual dollar weighted return for the fund.

24. Estimate the annual dollar weighted return for the fund assuming simple interest.

25. Estimate the annual dollar weighted return for the fund assuming simple interest and all cash flows occurred in the middle of the year.

26. Zaki has a bank account balance of X on January 1, 2000. During the next two years Zaki deposits 8000 into his account and withdraws 3000. On January 1, 2002, Zaki has a bank account balance of 28,400.

Assuming that all cash flows occur on January 1, 2001, Zaki estimates his annual dollar weighted return to be 4.5383664%.

Calculate X.

27. Question 1 in the Book.

28. Question 2 in the Book.

Chapter 2, Section 7

29. Sheila invests 1000 in a fund. One year later her investment is worth 800. At that time, Sheila invests an additional 500 into the fund. Two years after her initial investment of 1000, her fund is worth 2000.

Calculate Sheila’s time weighted yield (jTW) over the two year period as well as her annualized time weighted yield (iTW).

Use the following information about an investment fund for problems 30:

|Time |Fund Value Before Contributions |Contributions |

|0 |10,000 |0 |

|¼ |8,000 |-3,000 |

|½ |8,000 |3,000 |

|¾ |12,000 |3,000 |

|1 |15,000 |0 |

30. Calculate the annual time weighted yield for this fund.

31. Question 3 in the Book

Answers

1. 14.48%

2. -1.85%

3. 5.00%

4. 117 bags (You would actually get 117.72 bags, but you cannot buy a partial bag.)

5. See Appendix B of Book

6. See Appendix B of Book

7. See Appendix B of Book

8. See Appendix B of Book

9. 2004.23

10. 0.1450818 years

11. See Appendix B of Book

12. See Appendix B of Book

13. See Appendix B of Book

14. See Appendix B of Book

15. See Appendix B of Book

16. See Appendix B of Book

17. See Appendix B of Book

18. See Appendix B of Book

19. 6.2659%

20. 10.6682%

21.

a. 11.1574%

b. 9.8980%

c. 12.0210%

22. 9.0667%

23. 20.1352%

24. 20.0000%

25. 17.3913%

26. 21,200

27. See Appendix B of Book

28. See Appendix B of Book

29. 23.0769% and 10.9400%

30. 39.6364%

31. See Appendix B of Book

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