Inflation and Real Rates of Return Essay Example | Topics and Well Written Essays - 1500 words

Inflation and Real Rates of Return - Essay ExampleReal interest rates can be positive as well as negative. A positive real interest rate indicates that the purchasing power of the individual is increasing while a negative interest rate shows that the purchasing power of the individual is decreasing if the individual invests at the nominal rate. From the calculations above, it can be understood that at the circulating(prenominal) level of inflation, if a person invests in 1-year Certificate of Deposits, he will end up with less purchasing power. It can be analysed in much(prenominal) a way that a high inflation rate than the nominal interest rate means that the purchasing power is decreasing at a faster rate than the rate of return of the investment. 2. Du proportionalityn (Bonds) a. Frederick Macaulay developed a method to measure the interest rate risk of a bond and called it Macaulay Duration. He felt that duration is a better measure of the bonds worth than its time to maturity because duration considers both the repayment of capital at maturity and the size and timing of coupon payments before maturity (Macaulay Duration). Macaulay Duration is the weighted average term to maturity of the cash flows from a bond. The weight of distributively cash flow is determined by dividing the present value of the cash flow by the price (Macaulay Duration Definition). Duration measures a bonds price sensitivity to interest rate changes. ... Calculating V- I/Y= 9% V- = $92.406 Calculating V+ I/Y= 11% V+ = $87.781 3. Price-Earnings dimension a. False. The PE ratio is equal to the market price of the care divided by the earnings per share (EPS). If we are using the dividend discount model to estimate the share price, a higher beta would lead to a higher required rate of return. This would decrease the share price and as a result the PE ratio will decrease. b. True. The PE ratio tells us how much an investor is willing to pay for $1 of a companys earnings. If the net in come of a company is good then(prenominal) the investors will be willing to pay more for a dollar earned. The ROE is equal to the net income divided by the average shareholders equity. A higher net income means a higher ROE. c. False. If we are using the dividend discount model to estimate the share price, higher dividends will result in a higher share price. Higher share price will increase the PE ratio. When the plowback rate is higher the dividends will be lower. 4. Book Value a. The market to reserve value signifies how many times a companys stock is operating per share compare to the companys book value per share. The shapings book value reflect historic costs, hence this ratio is significant in indicating the warinesss success in adding value for its shareholders in case of the market value being higher than the book value. A high price to book value ratio means that shareholders expect the management of the company to create more value with the given level of assets. b. habitual shareholders equity = (20,000 x 20) + 5,000,000 + 70,000 Common shareholders equity = $5,470,000 Book value per share = Common shareholders equity / Number of common shares outstanding Book value per share = 5,470,000 /