Question: Robert Ford Simpson is a simple man who, at the age of 25, is aware that life requires much planning and wisdom. He currently lives in Australia, but would one day like to retire to a nice beach in Queensland. In Australia, retirement is at the age of 65 for a male. He is relatively well off, working at a major investment bank. Having a thorough knowledge of finance, he understands the importance of saving and the time value of money. To this end, he saves $2,000 per month for the next 10 years.
Financial markets are experiencing a boom of late, due to major government infrastructure projects. It is estimated that during Robert's working life the effective annual rate of return will be 11%. During retirement, the construction boom is expected to slow with effective annual rates declining to 8%.
Robert is very driven, ambitious, and disciplined. He develops many goals in relation to his retirement and investment goals.
Firstly, he reasons that given the cost of living, he will require a retirement income of $15,000 per month for 25 years. The first retirement payment will be received at end of the first month of his retirement.
Secondly, he would like to purchase a small apartment in Port Douglas, in 10 years' time. The current value of an apartment is $200,000. Average values have, over the past 100 years, grown at a rate of 5.5% per annum.
Thirdly, given he does not wish to have children, Robert realises that he might accumulate a substantial amount of wealth without leaving a legacy once he passes away. He would, therefore, like to leave a large inheritance of at least $1,000,000 to his niece, Delores. After the 20th year of his retirement we would like to give the $1,000,000 to his niece.
Answer the following questions. Show all workings.
What is the nominal rate of return associated with the two phases of Robert's life? Assume a monthly frequency. Why do we require the nominal rate of return?