   Chapter 6, Problem 16P Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. A 6-year security with no maturity, default, or liquidity risk has a yield of 20.84%. If the real risk-free rate is 6%, what average rate of inflation is expected in this country over the next 6 years? (Hint: Refer to “The Links between Expected Inflation and Interest Rates: A Closer Look” on page 206.)

Summary Introduction

To identify: The expected inflation rate.

Introduction:

Expected Inflation Rate:

The estimated, rate which indicates the general rise in price level of goods and services in the market, and currency’s decreased level of purchasing power is called expected inflation rate.

Explanation

Given,

The yield is 20.84.

The risk free rate is 6% or 0.06.

Formula to calculate the inflation rate derives from the formula of expected yield,

(1+r)=(1+r*)×(1+AverageInflation)AverageInflation=(1+r)(1+r*)1

Where,

• r is the expected yield

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