CFA Practice Question

CFA Practice Question

Inflation is expected to average 3.5% over each of the next five years. If an annuity pays $7,250 per year, at year-end, what is its present value if investors demand a real return of 3%?
A. $30,129
B. $33,203
C. $35,713
Explanation: Investors require a rate of return = real rate + inflation premium = 3 + 3.5 = 6.5%

Using a financial calculator: PMT = 7,250; I/Y = 6.5; N = 5; CPT PV = 30,129

User Contributed Comments 9

User Comment
danlan Another way is to use CF, C01=7250, F01=5, I=6.5 ==> NPV=30129
CjjCjj you would use the real rate of return only if the annuity paid an inflation adjusted amount.
copus be careful on these annuity questions - they will try to trip you up by the timing of the annuity payment (ie at the beginning or at the end of the year).
jansen1979 One should add FV = 0 to above calculator technique.
mixer always remember to 2nd clr TVM wnenever going for a new calculation you avoid write offs
Oksanata why would they say that investors DEMAND 3% return? messing up....
CalebMast Yeah, the 0 for FV tripped me up on calculator. Notes on beginning of year and only if inflation adjusted quite helpful.
@Oksanata - the demanded return gets added to inflation. Inflation is not return. Real return is above inflation - really it's "above and beyond" inflation, so stated real return demanded by investors is simply added to inflation (considered base, or even faux) #.
IreneK The calculator gives me -32,087 as a result... I can't get what's wrong...
mmccoy @Irenek set your calculator to END mode. You get 32,087 in BGN mode.
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