# Lg1 62 real rate of interest to estimate the real

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Unformatted text preview: he basis of the information that Carl has collected, what estimate can he make of the real rate of return? LG1 6–2 Real rate of interest To estimate the real rate of interest, the economics division of Mountain Banks—a major bank holding company—has gathered the data summarized in the following table. Because there is a high likelihood that new tax legislation will be passed in the near future, current data as well as data reflecting the probable impact of passage of the legislation on the demand for funds are also included in the table. (Note: The proposed legislation will not have any impact on the supply schedule of funds. Assume a perfect world in which inflation is expected to be zero, funds suppliers and demanders have no liquidity preference, and all outcomes are certain.) 296 PART 2 Important Financial Concepts With passage of tax legislation Currently Amount of funds supplied/demanded (\$ billion) Interest rate required by funds suppliers Interest rate required by funds demanders Interest rate required by funds demanders \$1 2% 7% 9% 5 3 6 8 10 4 4 7 20 6 3 6 50 7 2 4 100 9 1 3 a. Draw the supply curve and the demand curve for funds using the current data. (Note: Unlike the functions in Figure 6.1, the functions here will not appear as straight lines.) b. Using your graph, label and note the real rate of interest using current data. c. Add to the graph drawn in part a the new demand curve expected in the event that the proposed tax legislation becomes effective. d. What is the new real rate of interest? Compare and analyze this finding in light of your analysis in part b. LG1 6–3 Real and nominal rates interest Zane Perelli currently has \$100 that he can spend today on polo shirts costing \$25 each. Instead he could invest the \$100 in a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of interest. The consensus forecast of leading economists is a 5% rate of inflation over the coming year. a. How many polo shirts can Zane purchase today? b. How much money wil...
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