Question

Your grandfather advised you to invest $10,000 in a CD because that is how he saved his money back in the 70's and 80's. You do some research and find that the best CD rate has an annual rate of return of 0.7%. According to another internet search, inflation is projected to be at 2.2% over the next two years. What will be the real future value of the investment (using the real interest rate) at the end of the 2-year deposit term

Answer 1

The real future value of the investment (using the real interest rate) at the end of the 2-year deposit term will be $9,702.25.

Step-by-step explanation:

To calculate this, we first calculate the real interest using the real interest formula as follows:

Real interest ratev= Nominal interest rate – Projected inflation rate …………………. (1)

Where;

Nominal interest rate = Annual rate of return = 0.7%

Inflation rate = 2.2%

Substituting the values into equation (1), we have:

Real interest rate = 0.7% - 2.2% = -1.50%, or -0.015

The real future value of the investment (using the real interest rate) at the end of the 2-year deposit term, can now be calculated using the future value formula as follows:

FV = P * (1 + r)^n ................. (2)

Where;

FV = real future value of the investment = ?

P = Amount to invest = $10,000

r = Real interest rate = -1.50%, or -0.015

n = number of years = 2

Substituting the values into equation (2), we have:

FV = $10,000 * (1 - 0.015)^2

FV = $10,000 * 0.970225

FV = $9,702.25

Therefore, the real future value of the investment (using the real interest rate) at the end of the 2-year deposit term will be $9,702.25.