You buy a certificate of deposit (CD) that pays a nominal rate of 12% annually. You have a tax rate of 25%, so if the interest on this CD is taxable (which it may not be) your after-tax nominal rate is (1 ? 25%) "c 12% = 9%. Since 10% equals .1, we can rewrite the equation as: (1 ? .25) "c .12 = .09. For parts (A-C), the nominal rate if 12%,annually and the after-tax nominal rate is 9%.
A. If the inflation rate is 6% and interest on this CD is not taxable, what is the real interest rate on the CD? Hint: What is the relationship between the real rate of interest and the nominal rate of interest?
B. If the inflation rate is 6% and the interest on this CD is taxable, what is the real interest rate on the CD?
C. How does taxation of interest affect the real return on the CD when the nominal rate is 12% and inflation is 6%?
D. Now, if the inflation rate is 18%, the nominal rate of interest on the CD is 24%,and the interest is not taxable, what is the real interest rate on the CD?
E. If the inflation rate is 18%, the nominal rate of interest on the CD is 24%, and the interest is taxable (at a rate of 25%), what is the after-tax real interest rate on the CD? Hint: first calculate the after-tax nominal rate.