Question: Present and Future Values

A. You will receive $100 from a savings bond in 3 years. The nominal interest rate is 8

percent.

(i) What is the present value of the proceeds from the bond?

(ii) If the annual inflation rate over the next 3 years is expected to be 5 percent, what will be the real value (i.e., purchasing power) of the $100 payoff in terms of today’s dollars?

(iii) What is the real interest rate?

(iv) Show that the real payoff from the bond (from part (ii)) discounted at the real interest

rate (from part (iii)) gives the same present value for the bond as you found in part (I).

B. In order to live comfortably in retirement, Madonna will need to have saved $2,000,000 by the time she retires in 40 years. If the interest rate she earns on her savings is 5 percent per year, what fixed amount must she save each year to meet her retirement goal?