Chapter 10. Time Value of Money 2: Understanding
Inflation, Real Returns, Annuities, and
Amortized Loans
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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)