P6–3 Real and nominal rates of interest Zane Perelli currently has $100 that he can spend today on polo shirts costing $25 each. Alternatively, he could invest the $100 in a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of interest. The consensus forecast of leading economists is a 5% rate of inflation over the coming year.

a. How many polo shirts can Zane purchase today?

b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today?

c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation?

d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy at the end of 1 year?

e. What is Zane’s real rate of return over the year? How is it related to the percentage change in Zane’s buying power found in part d? Explain.