Question 1

The market interest rate in Alpha is 7%, and the market interest rate in Beta is 10%; the inflation rate in Alpha is 3%, and inflation rate in Beta is 8%.Which of the following statements is true?
A)The real interest rate is higher in Alpha, but the nominal interest rate is higher in Beta.
B)The real interest rate is higher in Beta, but the nominal interest rate is higher in Alpha.
C)Both the real and nominal interest rates are higher in Alpha.
D)Both the real and nominal interest rates are higher in Beta.

Accepted Answer

The real interest rate is calculated as the nominal interest rate minus the inflation rate. In Alpha, the real interest rate is 7% - 3% = 4%. In Beta, it is 10% - 8% = 2%. Thus, the real interest rate is higher in Alpha, but the nominal interest rate is higher in Beta.

Question 2

On January 1, 2008, Anna invested $5,000 at 5% interest for one year.The CPI on January 1, 2009 stood at 1.60.On January 1, 2009, the CPI was 1.68.The real rate of interest earned by Anna was ______ percent.
A)-5
B)0
C)5
D)8

Accepted Answer

The real rate of interest is calculated by adjusting the nominal interest rate for inflation. The nominal interest rate is 5%. The inflation rate is calculated as (1.68 - 1.60) / 1.60 = 0.05 or 5%. Therefore, the real rate of interest is 5% - 5% = 0%.

Question 3

For a given nominal interest rate, an unexpectedly high inflation rate ______ the real interest rate.
A)increases
B)decreases
C)has no impact on
D)may either increase or decrease

Accepted Answer

An unexpectedly high inflation rate decreases the real interest rate. This is because inflation erodes the purchasing power of money over time, reducing the real value of the interest payments received by lenders. Therefore, the inflation rate and the real interest rate are inversely related.

Question 4

If the bank agrees to make a loan at a 7% interest rate and the inflation rate is 3%, then 4% is the ______ rate.
A)nominal interest
B)real interest
C)hyperinflation
D)disinflation

Accepted Answer

The real interest rate is the nominal interest rate minus the inflation rate. In this case, the nominal interest rate is 7% and the inflation rate is 3%, so the real interest rate is 4%.

Question 5

An investor purchasing an inflation-protected bond with a fixed annual real return of 1.75 percent will earn a nominal annual return of ______ percent if the actual inflation rate turns out to be 3.25 percent.
A)1.50%
B)1.86%
C)5.00%
D)5.69%

Accepted Answer

The answer of An investor purchasing an inflation-protected bond with...

Question 6

Marge is lending Martin $1,000 for one year.The CPI is 1.60 at the time the loan is made.They expect it to be 1.76 in one year.If Marge and Martin agree that Marge should earn a 3% real return for the year, the nominal interest rate on this loan should be ______ percent.
A)3
B)7
C)13
D)16

Accepted Answer

The nominal interest rate can be calculated using the formula: nominal rate = real rate + inflation rate. The inflation rate is calculated as (1.76 - 1.60) / 1.60 = 0.1 or 10%. Therefore, the nominal rate = 3% + 10% = 13%.

Question 7

Unexpectedly high inflation ______ borrowers and ______ lenders.
A)helps; hurts
B)helps; helps
C)hurts; hurts
D)hurts; helps

Accepted Answer

This is one of the biggest costs of inflation: the transfer of wealth from lenders to borrowers in periods of unexpectedly high inflation.

Question 8

Samantha is lending Jack $1,000 for one year.The CPI is 1.60 at the time the loan is made, and they both expect it to be 1.68 in one year.If Samantha and Jack agree that Samantha should earn a 3% real return for the year, the nominal interest rate on this loan should be ______ percent.
A)3
B)5
C)8
D)11

Accepted Answer

The nominal interest rate can be calculated using the formula: (1 + nominal rate) = (1 + real rate) * (1 + inflation rate). The expected inflation rate is (1.68/1.60) - 1 = 0.05 or 5%. Therefore, (1 + nominal rate) = (1 + 0.03) * (1 + 0.05) = 1.0815, which implies a nominal rate of approximately 8%.

Question 9

If the annual real rate on a 10-year inflation-protected bond equals 1.9 percent and the annual nominal rate of return on a 10-year bond without inflation protection is 4.4 percent, what average rate of inflation over the ten years would make holders of inflation-protected bonds and holders of bonds without inflation protection equally well off?
A)1.9%
B)2.5%
C)4.4%
D)6.3%

Accepted Answer

The average rate of inflation that would make holders of both bonds equally well off is the difference between the nominal rate and the real rate, which is 4.4% - 1.9% = 2.5%.

Question 10

On January 1, 2008, Edward invested $10,000 at 5% interest for one year.The CPI on January 1, 2008 stood at 1.60.On January 1, 2009, the CPI was 1.76.The real rate of interest earned by Edward was ______ percent.
A)-5
B)0
C)5
D)10

Accepted Answer

The answer of On January 1, 2008, Edward invested $10,000...

Question 11

For a given nominal interest rate, an unexpectedly low inflation rate ______ the real interest rate.
A)increases
B)decreases
C)has no impact on
D)may either increase or decrease

Accepted Answer

Because the real interest rate equals the nominal interest rate minus the inflation rate, a lower than expected inflation rate increases the real interest rate. So the lender gets an unexpected bonus.

Question 12

If both the lender and borrower agree on an 8% interest rate, both expect a 4% inflation rate, and inflation turns out to be 4%, then ______ by the inflation.
A)the borrower is hurt and the lender gains
B)the borrower gains and the lender is hurt
C)neither the borrower nor the lender are hurt
D)both the borrower and lender are hurt

Accepted Answer

The expected inflation rate was 4%, and the actual inflation rate was also 4%. Therefore, both the borrower and lender's expectations were met, and neither is hurt by the inflation.

Question 13

Assume one investor bought a 10-year inflation-protected bond with a fixed annual real rate of 1.5% and another investor bought a 10-year bond without inflation protection with a nominal annual return of 4.2%.If inflation over the 10-year period averaged 3%, which investor earned a higher real return?
A)The investor who purchased the inflation protected bond.
B)The investor who purchased the bond without inflation protection.
C)Both investors earned the same real return.
D)Neither investor earned a positive real return.

Accepted Answer

The investor with the inflation-protected bond earned a real return of 1.5%, as it is adjusted for inflation. The investor with the nominal bond had a real return of 4.2% - 3% = 1.2%. Therefore, the inflation-protected bond investor earned a higher real return.

Question 14

If the annual real interest rate on a 10-year inflation-protected bond equals 1.5 percent and the annual nominal rate of return on a 10-year bond without inflation protection is 4.2 percent, what average rate of inflation over the ten years would make holders of inflation-protected bonds and holders of bonds without inflation protection equally well off?
A)1.5%
B)2.7%
C)4.2%
D)5.7%

Accepted Answer

The average rate of inflation that would make both bondholders equally well off is the difference between the nominal rate and the real rate, which is 4.2% - 1.5% = 2.7%.

Question 15

The real rate of return on holding cash ______ inflation is correctly anticipated.
A)is higher when
B)is lower when
C)does not depend on whether
D)equals the nominal interest rate when

Accepted Answer

Because the nominal rate of return on holding cash is always zero regardless of the rate of inflation, the real rate of return does not depend on whether or not inflation is correctly anticipated. Only the actual inflation rate will impact the real rate of return on holding cash.

Question 16

The real rate of return on holding cash is equal to:
A)the nominal interest rate.
B)the real interest rate.
C)the expected inflation rate.
D)zero minus the inflation rate.

Accepted Answer

The real rate of return on holding cash takes into account the inflation rate. Therefore, the real rate of return on holding cash is equal to zero minus the inflation rate.

Question 17

If the borrower and lender agree to a loan at 8% when the inflation rate is 3%, then 8% is the ______ interest rate and 5% is the ______ interest rate.
A)real; nominal
B)nominal; real
C)relative; nominal
D)real; relative

Accepted Answer

The nominal interest rate is the stated rate on the loan, which is 8%. The real interest rate is the nominal rate minus the inflation rate, which is 5% (8% - 3%).

Question 18

Inflation-protected bonds guarantee investors:
A)no real wealth loss in the event of unexpectedly high inflation.
B)above average real returns.
C)a fixed nominal rate of return.
D)an above average rate of inflation.

Accepted Answer

Inflation-protected bonds are designed to protect investors from the effects of inflation by adjusting their principal and interest payments based on changes in the inflation rate. Therefore, investors are guaranteed that their investment will maintain its purchasing power and avoid real wealth loss in the event of unexpectedly high inflation.

Question 19

The nominal return on an inflation-protected bond equals a fixed real return:
A)plus the actual rate of inflation.
B)minus the actual rate of inflation.
C)divided by the price level.
D)plus the expected rate of inflation.

Accepted Answer

The attractive feature of inflation-protected bonds is they add an inflation premium to a known real return.

Question 20

Assume one investor bought a 10-year inflation-protected bond with a fixed annual real rate of 1.5% and another investor bought a 10-year bond without inflation protection with a nominal annual return of 4.2%.If inflation over the 10-year period averaged 2 %, which investor earned a higher real return?
A)The investor who purchased the inflation protected bond.
B)The investor who purchased the bond without inflation protection.
C)Both investors earned the same real return.
D)Neither investor earned a positive real return.

Accepted Answer

The answer of Assume one investor bought a 10-year inflation-protected...

Quiz 5: Inflation and the Price Level

The market interest rate in Alpha is 7%, and the market interest rate in Beta is 10%; the inflation rate in Alpha is 3%, and inflation rate in Beta is 8%.Which of the following statements is true?

On January 1, 2008, Anna invested $5,000 at 5% interest for one year.The CPI on January 1, 2009 stood at 1.60.On January 1, 2009, the CPI was 1.68.The real rate of interest earned by Anna was ______ percent.

For a given nominal interest rate, an unexpectedly high inflation rate ______ the real interest rate.

If the bank agrees to make a loan at a 7% interest rate and the inflation rate is 3%, then 4% is the ______ rate.

An investor purchasing an inflation-protected bond with a fixed annual real return of 1.75 percent will earn a nominal annual return of ______ percent if the actual inflation rate turns out to be 3.25 percent.

Marge is lending Martin $1,000 for one year.The CPI is 1.60 at the time the loan is made.They expect it to be 1.76 in one year.If Marge and Martin agree that Marge should earn a 3% real return for the year, the nominal interest rate on this loan should be ______ percent.

Unexpectedly high inflation borrowers and lenders.

Samantha is lending Jack $1,000 for one year.The CPI is 1.60 at the time the loan is made, and they both expect it to be 1.68 in one year.If Samantha and Jack agree that Samantha should earn a 3% real return for the year, the nominal interest rate on this loan should be ______ percent.

On January 1, 2008, Edward invested $10,000 at 5% interest for one year.The CPI on January 1, 2008 stood at 1.60.On January 1, 2009, the CPI was 1.76.The real rate of interest earned by Edward was ______ percent.

For a given nominal interest rate, an unexpectedly low inflation rate ______ the real interest rate.

If both the lender and borrower agree on an 8% interest rate, both expect a 4% inflation rate, and inflation turns out to be 4%, then ______ by the inflation.

The real rate of return on holding cash ______ inflation is correctly anticipated.

The real rate of return on holding cash is equal to:

If the borrower and lender agree to a loan at 8% when the inflation rate is 3%, then 8% is the interest rate and 5% is the interest rate.

Inflation-protected bonds guarantee investors:

The nominal return on an inflation-protected bond equals a fixed real return: