Basics of Investing

Archive for July, 2006

Question: Finance: Real Return and Inflation problem?

I keep trying to use the Fischer equation, but I keep ending up with the wrong answer to this question: Can you figure out what the inflation rate is?

An investment offers a 5.5% total return over the coming year. Bill Bernanke thinks the total real return on this investment will be only 2.5%. What does Bill believe the inflation rate will be over the next year?

Answer: r – real interest = 2.5%
π – inflation (expected, or “ex ante”)
i – nominal interest = 5.5%

(1+r) = (1+i) / (1+π)
(1+2.5%) = (1+5.5%) / (1+π)
1.025 = 1.055 / (1+π)
(1+π) = 1.055 / 1.025
π = 1.055/1.025 – 1=1.055/1.025 – 1.025/1.025= 0.03/1.025 ≈ 0.0293 ≈ 2.93%

THM Investments Billboard Event, with Charles Fisher and Lisa Kay Hansen