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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
($ billion) Interest rate
funds suppliers Interest rate
funds demanders Interest rate
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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