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Chapter 9
Inflation
4.1 Terminology
When describing cash flows it is important to clarify whether inflation is included
in the figures.
'Money’ cash flows include predicted inflation and other price rises
they are the actual cash flows that take place
e.g. If I am awarded a 3% pay rise, then my gross
salary will increase by 3% in money terms
‘Real’ cash flows have had general inflation taken out of them
If general inflation is 3% per annum, then a 3%
pay rise leaves me no better off in real terms
If inflation is only 2% then I am approximately 1%
better off in real terms
4.2 Switching between money and real rate indices
Real index = money index /inflation index
4.3 UK Inflation
RPI and CPI – both based on baskets of goods
Fixed quantity price indices
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