John invested $100 last year at a nominal interest rate of 10%. All the money with interest will be paid back this year. Suppose there is an inflation of 5% over the past year.
(1) How much will John receive in total this year? This is the total payment in today's dollar.
(2) Accounting for inflation, how much does the $100 from last year worth in this year? This is the value of initial investment in today's dollar.
(3) The real rate of return or the real interest rate equals to ((total payment in today's dollar) - (value of initial investment in today's dollar)) / (value of initial investment in today's dollar) Calculate the real interest rate.
(4) Verify that
Nominal Interest Rate = Real Interest Rate + Inflation + (Real Interest Rate x Inflation)
(5) If the inflation rate is 20% instead of 5%, is it a good idea for John to make this investment?