Question 1

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 112. What is your expected real rate of return?

Accepted Answer

To calculate the expected real rate of return, we use the formula:
Real rate of return = (1 + Nominal rate) / (1 + Inflation rate) - 1

Plugging in the given values, we get:
Real rate of return = (1 + 0.042) / (1 + 0.04) - 1
Real rate of return = 1.042 / 1.04 - 1
Real rate of return = 0.0192 or 1.92%

However, we need to adjust this for the expected increase in inflation. The increase in CPI from 108 to 112 represents a 3.7% increase in inflation ([(112-108)/108]*100).

So, the expected real rate of return is:
Real rate of return = (1 + 0.042) / (1 + 0.037) - 1
Real rate of return = 1.042 / 1.037 - 1
Real rate of return = 0.005 or 0.5%

Therefore, the answer is C) 0.5%.

Question 2

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?

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%.

Question 3

You open an investment account that earns a nominal interest rate of 3.1% per year. The current consumer price index is 205. In one year, the consumer price index is expected to go to 203. What is your expected real rate of return?

Accepted Answer

To find the expected real rate of return, we first need to calculate the inflation rate:

Inflation rate = ((203-205)/205) x 100% = -0.98%

Then, we can use the formula:

Real rate of return = nominal rate of return - inflation rate

Real rate of return = 3.1% - (-0.98%) = 4.08%

Therefore, the expected real rate of return is 4.08%, which corresponds to choice B.

Question 4

Hedging against inflation means:

Accepted Answer

Hedging against inflation involves investing in financial instruments that offer protection against inflation, such as Treasury Inflation-Protected Securities (TIPS) or stocks of companies with pricing power. Holding cash during periods of high inflation (option C) would actually result in losses in purchasing power, while purchasing goods and services only when prices are low (option D) may not be a feasible strategy for all goods and services. Option A is not a definitive hedging strategy.

Question 5

Shoe-leather costs of inflation are the costs:

Accepted Answer

Shoe-leather costs of inflation refer to the time and effort spent by individuals and businesses to avoid holding cash that will lose value due to inflation. This may involve making frequent trips to the bank or using alternative means of payment, all of which incur additional costs.

Question 6

The menu costs of inflation are the:

Accepted Answer

Menu costs refer to the costs incurred by firms in adjusting their prices due to inflation. The marginal cost of adjusting prices is a key component of menu costs, as firms must spend resources to change their pricing structures in response to changing inflation rates. Lost interest earnings on cash, the costs of information search, and the overall costs of purchasing inputs at higher prices are not direct components of menu costs.

Question 7

When inflation is higher than expected, there is redistribution from:

Accepted Answer

When inflation is higher than expected, the real value of money decreases, meaning the real value of the debt decreases. This benefits borrowers, who have to pay back less in real terms, and disadvantages lenders, who receive less in real value.

Question 8

You can hedge against inflation by investing in:

Accepted Answer

Investing in inflation-indexed bonds is seen as the best option to hedge against inflation as these bonds are specifically designed to provide returns that keep pace with inflation. Housing and art may appreciate in value over time but may not necessarily keep up with inflation. Cash is not a viable option as inflation can erode the purchasing power of cash over time.

Question 9

Why should you avoid holding cash during periods of high inflation?

Accepted Answer

Cash loses value during periods of high inflation because as prices keep increasing, the purchasing power of the money decreases. Therefore, it is advisable to avoid holding cash during periods of high inflation.

Question 10

A savvy investor seeks:

Accepted Answer

A savvy investor seeks inflation-indexation clauses as they protect against the negative effects of inflation on an investment.

Question 11

If you didn't get a cost of living increase in your paycheck this year:

Accepted Answer

If deflation occurs, the general level of prices is decreasing, which means the purchasing power of money increases. Therefore, even without a nominal increase in your paycheck, you can buy more with the same amount of money, effectively increasing your purchasing power.

Question 12

Even if inflation exists, your purchasing power from one period to the next will stay intact if:

Accepted Answer

When your pay rise matches the rate of inflation, it means your income increases at the same rate as prices, maintaining your purchasing power.

Question 13

If there is deflation of 2% in the economy, your purchasing power will remain the same if your income:

Accepted Answer

If there is deflation of 2% in the economy, the prices of goods and services will fall by 2%. In order to maintain the same purchasing power, your income must also fall by 2%.

Question 14

Suppose the basket of goods that you purchase in 2019 consists of five textbooks, three jackets, one pair of winter boots, and four pairs of socks. In 2019, each textbook was $105, each jacket was $75, the pair of winter boots was $90, and each pair of socks was $3. Now suppose in 2020, you purchase the same basket: each textbook costs $97.50, each jacket costs $79, the pair of winter boots is $90, and each pair of socks is $2.50.
(a) What is the cost of the basket in 2019?
(b) What is the cost of the basket in 2020?
(c) What is the rate of inflation or deflation during in 2020?

Accepted Answer

The answer of Suppose the basket of goods that you...

Question 15

Each month, Lydia typically purchases 12 sodas, seven hot-dogs, five ice-cream cones, eight salads, and four roast chickens. Two years ago, Lydia paid $1.50 for each soda, $2.50 for each hot-dog, $4 for each ice-cream cone, $9 for each salad, and $7.99 for each roast chicken. Today, Lydia pays $1.75 for each soda, $3 for each hot dog, $4.50 for each ice-cream, $9 for each salad, and $8.99 for each roast chicken.
(a) How much did Lydia's purchases cost her two years ago?
(b) How much is Lydia paying for her purchases today?
(c) How much inflation or deflation is Lydia experiencing?

Accepted Answer

The answer of Each month, Lydia typically purchases 12 sodas,...

Question 16

The table shows consumer price index data for the United States. Use these data to answer the following questions.
 $$\begin{array}{l}
\text { U.S. CONSUMER PRICE INDEX }\
\begin{array} { | c | c | } 
\hline \text { YEAR } & \begin{array} { c } 
\text { CONSUMER } \
\text { PRICE INDEX }
\end{array} \
\hline 1979 & 72.58 \
\hline 1980 & 82.38 \
\hline 1981 & 90.93 \
\hline 1982 & 96.53 \
\hline 1983 & 99.58 \
\hline 1984 & 103.93 \
\hline
\end{array}
\end{array}$$ ​
(a) What was the inflation rate in 1981?
(b) What was the inflation rate in 1982?
(c) Out of the years shown in the table, which year had the highest rate of inflation?

Accepted Answer

The answer of The table shows consumer price index data...

Question 17

Use the following consumer price index data to answer the questions.
 $$\begin{array} { | c | c | } 
\hline \text { YEAR } & \begin{array} { c } 
\text { CONSUMER } \
\text { PRICE INDEX }
\end{array} \
\hline 2001 & 169.8 \
\hline 2002 & 174.6 \
\hline 2003 & 182.0 \
\hline 2004 & 180.8 \
\hline 2005 & 177.6 \
\hline 2006 & 179.1 \
\hline
\end{array}$$ ​
(a) What was the inflation rate in 2003?
(b) What was the inflation rate in 2005?
(c) Out of the years shown in the table, which year(s) experienced deflation?
​

Accepted Answer

The answer of Use the following consumer price index data...

Question 18

Use the following consumer price index data to answer the questions.
 $$\begin{array} { | c | c | } 
\hline \text { YEAR } & \begin{array} { c } 
\text { CONSUMER } \
\text { PRICE INDEX }
\end{array} \
\hline 1997 & 97.8 \
\hline 1998 & 99.2 \
\hline 1999 & 100 \
\hline 2000 & 102.5 \
\hline 2001 & 105 \
\hline 2002 & 108.4 \
\hline
\end{array}$$ ​
(a) What was the inflation rate in 2001?
(b) What was the inflation rate in 1998?
(c) Which year is the base year?
(d) Out of the years shown in the table, which year had the highest rate of inflation?
​
​

Accepted Answer

The answer of Use the following consumer price index data...

Question 19

In January of this year, Lorina opens an investment account that has a nominal interest rate of 3.8%. The consumer price index in January was 211.93 and is expected to go to 213.21 in a year. Suppose that the consumer price index actually turns out to be 209.75 in a year. Based on this information, answer the following questions.
(a) What is the expected rate of inflation over the year?
(b) What is Lorina's expected real interest rate?
(c) What is Lorina's actual real rate of interest?

Accepted Answer

The answer of In January of this year, Lorina opens...

Question 20

In January of this year, Max purchases a financial instrument that has a nominal interest rate of 2.75%. The consumer price index in January was 211.93 and is expected to be 213.21 in a year. Suppose the consumer price index actually turns out to be 215.47 in one year. Based on this information, answer the following questions.
(a) What is the expected rate of inflation over the year?
(b) What is Max's expected real interest rate?
(c) What is Max's actual real rate of interest?

Accepted Answer

The answer of In January of this year, Max purchases...

Quiz 24: Inflation and Money

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 112. What is your expected real rate of return?

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?

You open an investment account that earns a nominal interest rate of 3.1% per year. The current consumer price index is 205. In one year, the consumer price index is expected to go to 203. What is your expected real rate of return?

Hedging against inflation means:

Shoe-leather costs of inflation are the costs:

The menu costs of inflation are the:

When inflation is higher than expected, there is redistribution from:

You can hedge against inflation by investing in:

Why should you avoid holding cash during periods of high inflation?

A savvy investor seeks:

If you didn't get a cost of living increase in your paycheck this year:

Even if inflation exists, your purchasing power from one period to the next will stay intact if:

If there is deflation of 2% in the economy, your purchasing power will remain the same if your income: