CM1 ch12 pg 31 - Money Yield

[Brett Kim]

The question on page 31 of chapter 12 asks us to calculate the money yield given an inflation rate of 5% p.a. and spending of $100,000 at the outset, with an expected return of $110,000 in one year's time.

The solution to (i) calculates the present value of $110,000 inflated by 5%, giving a money yield of 15.5% p.a.

However, I thought the money yield was the yield that didn't include the effect of inflation? Hence the money yield is simply 10%?

 

[Noreen]

My way of thinking about this is that the money yield is when you get the yield using the actual amounts of money involved and not adjusting for inflation, so taking the amount received in a year and not adjusting back to todays money. The actual amount of money received in one year will be 110,000*1.05=115500

100000*(1+i)=115500 and solving for i, i=15.5% (money yield)

Then the real yield is when you solve for the yield when the amounts are in todays money so the the monetary amount of 115500 in one years time is 110000 in todays money when adjusted for inflation.

100000*(1+i)=110000 and solving for i, i=10% (real yield)

 

[Brett Kim]

I see. In dollar terms, at time t1 you would be receiving $115,500 because of inflation. But then you adjust that back into dollars at t0, hence why we call it adjusting for inflation. That makes a lot of sense. Thanks very much!