You open an investment account that earns a nominal interest rate of 4.2% a year. The current consumer price index is 108. In one year, the consumer price index is expected to go to 106. What is your expected real rate of return?
A)-1.85%
B)4.2%
C)6.05%
D)7.35%

Question

Quizplus · Accepted Answer

The real rate of return is calculated using the formula: Real Rate = Nominal Rate - Inflation Rate. Here, the nominal rate is 4.2%. The inflation rate is calculated based on the change in the consumer price index (CPI). Since the CPI is expected to decrease from 108 to 106, this indicates deflation rather than inflation. The inflation rate can be calculated as: [(106 - 108) / 108] * 100 = -1.85%. Therefore, the real rate of return is 4.2% - (-1.85%) = 6.05%.

You Open an Investment Account That Earns a Nominal Interest