Question

You lent $680 to a friend for one year at a nominal rate of interest of 3 percent. Inflation during that year was 2 percent. Did you experience an increase or decrease in the purchasing power of your money

Answer 1

Answer:

the purchasing power of the money increased

Explanation:

first we must calculate the future value of the money that was lent:

future value = present value x (1 + interest rate) = $680 x 1.03 = $700.40

if we want to know if the purchasing power of our money remains the same or not, we must discount the future value of the loan using inflation rate as the discount rate:

present value = future value / (1 + discount rate) = $700.40 / 1.02 = $686.67

the net present value of our loan = $686.67 - $680 = $6.67, so the purchasing power of our money increased