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A loan of $400,000 is taken out which requires an annual interest payment of 4.4% of the borrowed amount of money (in market dollars). No principal payments are made, only interest is paid. Inflation is 3.8% per year. What will be the value of interest payment at the end of fourth year in real dollars?

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Answer:

payment in real dollars 4 years later = $15,160.84

Explanation:

in current dollars, the interest payment = $400,000 x 4.4% = $17,600

if the inflation rate is 3.8% annual, the value of real dollars will increase by (1 + 3.8%)⁴ - 1 = 1.1609 - 1 = 16.09%

this means that we need to discount the nominal payment by $16.09%;

payment in real dollars 4 years later = $17,600 / (1 + 16.09%) = $15,160.84

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