Oakwood University How Many Socks Can Zane Purchase Today Case Study Questions

Real and nominal rates of interest Zane Perelli currently has $100 that he can spend today on socks costing $2.50 each. Alternatively, 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.

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a. How many socks can Zane purchase today?

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b. How much money will Zane have at the end of 1 year if he forgoes purchasing the socks today and invests his money instead?

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c. How much would you expect the socks to cost at the end of 1 year in light of the expected inflation?

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d. Use your findings in parts b and c to determine how many socks (fraction are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer socks can Zane buy at the end of 1 year?

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c. What is Zane’s real rate of return over the year? How is it related to the percentage change in Zane’s buying power found in part d? Explain.