Financial issues: loans, mortgage, investment

If investors expected the price level to increase during the investment period, they would require the rate of return to include compensation for the expected rate of inflation. Assume that you require a 4 percent real rate of return on a risk-free investment but you expect prices to increase by 3 percent during the investment period. In this case, you should increase your required rate of return by this expected rate of inflation to about 7 percent [(1.04 × 1.03) – 1]. If you do not increase your required return, the $104 you receive at the end of the year will represent a real return of about 1 percent, not 4 percent. Because prices have increased by 3 percent during the year, what previously cost $100 now costs $103, so you can consume only about 1 percent more at the end of the year [($104/103) – 1]. If you had required a 7.12 percent nominal return, your real consumption could have increased by 4 percent [($107.12/103) – 1].

Price movement is usually viewed as a chart on which each new time period is seen as a new bar or point recorded to the right of the previous prices. There are many applications that need to look at the way prices cluster, or distribute, rather than sequences of patterns. In options, it is important to evaluate the current market volatility to decide the chances of prices remaining in a specific range for a specific amount of time. The standard deviation gives the most basic measure of price distribution. From the value of 1 standard deviation we can estimate the chances of a price remaining within a range over time. The key values to remember are that 1 standard deviation defines 68% of the price movement (both up and down), 2 standard deviations contain 95%. and 3 standard deviations contain 99% of all price movement based on the sample of data used to calculate the standard deviation value.