In Reading 30, Blue Box Example 4 “Core Capital with Mortality Probabilities” I’m struggling to understand Year 2 and Year 3 discount rates. I understand that for Year 2 the expected spending is $999,730 and Year 3 is $999,300, but what discount rates are they using to get to those Discounted Value numbers and how are they getting to the discount rates for years 2 and 3? thanks
It’s stated in the solution. They are using the real discount rate, as the spending is in real terms.
Real discount rate = Nominal discount rate - Expected inflation = 5% - 3% = 2%