10-TVM-2.pdf - Chapter 10 Time Value of Money 2 Understanding Inflation Real Returns Annuities and Amortized Loans 10 Time Value of Money 2

10-TVM-2.pdf - Chapter 10 Time Value of Money 2...

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Chapter 10. Time Value of Money 2: Understanding Inflation, Real Returns, Annuities, and Amortized Loans - 220 - 2018-2019 Edition 10. Time Value of Money 2: Understanding Inflation, Annuities, and Amortized Loans Introduction This chapter continues the discussion on the time value of money. In this chapter, you will learn how inflation impacts your investments; you will also learn how to calculate real returns after inflation as well as annuities and payments on amortized loans. Objectives Once you have completed this chapter, you should be able to do the following: 1. Explain how inflation impacts your investments 2. Understand how to calculate real returns (returns after inflation) 3. Solve problems related to annuities 4. Solve problems related to amortized loans Explain How Inflation Impacts Your Investments Inflation is an increase in the volume of available money in relation to the volume of available goods and services; inflation results in a continual rise in the price of various goods and services. In other words, because of increased inflation, your money can buy fewer goods and services today than it could have bought in the past. Inflation negatively impacts your investments. Although the amount of money you are saving now will be the same amount in the future, you will not be able to buy as much with that money in the future (the purchasing power of your money erodes). Inflation makes it necessary to save more because your currency will be worth less in the future. Problem 1: Inflation Forty years ago, gum cost five cents a pack. Today it costs 99 cents a pack. Assume that the increase in the price of gum is completely related to inflation and not to other factors. At what rate has inflation increased over the last 40 years? Before solving this problem, clear your calculator’s memory, and set your calculator to one annual payment. Then input the following information to solve this problem: PV = –$0.05 (the price of gum forty years ago)
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