Question

Suppose the real interest rate is 2.8%, and the inflation rate is 7%. (1) How much do you need to invest now in order to get $100 in a year? Please show two approaches to calculate the answers. (Round your final answer to two decimal places) (2) Suppose the U.S. Treasury issues 5% coupon, 3-year TIPS (Treasury Inflation-Protected Securities). What are the real cash flows on the 3-year TIPS each year? What are the nominal cash flows on the 3-years TIPS each year? (Round your final answers to two decimal places) Essay Toolbar navigation B I IC Ꭶ A A

Answer 1

	Real Interest rate	2.8%
	Inflation rate	7%
1)
	Approach 1
	Nominal Interest rate = Real Interest rate + Inflation rate
	Nominal Interest rate = 2.8%+7%
	Nominal Interest rate = 9.8%
	Amount needed to Invest to get $100 in a year	91.07468124
	[= $100/(1+Nominal interest rate)]	[= $100/(1+9.8%)]
	Approach 2
	(1+Nominal Interest rate) = (1+Real Interest rate )* (1+Inflation rate)
	(1+Nominal Interest rate) = (1+2.8%)+ (1+7%)
	(1+Nominal Interest rate) = (1+2.8%)+ (1+7%)
	(1+Nominal Interest rate) =	1.099960
	Nominal Interest rate =	9.96%
	Amount needed to Invest to get $100 in a year	90.91239681
	[= $100/(1+Nominal interest rate)]	[= $100/(1+9.96%)]
2)	US treasury TIPS coupon rate =5%
	Nominal Interest rate = US treasury TIPS coupon rate =5%
	Real Interest rate = 2.8%
	It is assumed initial amount to be $100
	Real Cashflows each year	$                       5.00
		[=100*5%]
	Nominal Cashflows each year	$                       2.80
		[=100*2.8%]