USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below returned the following nominal rates of return.

-Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5 percent to 2.5 percent, what will be the nominal rate of return on each security?
A) 1.24% and 1.52%
B) 1.35% and 3.52%
C) 3.89% and 6.11%
D) 3.52% and 3.89%
E) 1.17% and 6.11%

Question

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that during the past year the consumer price index increased by 1.5 percent and the securities listed below returned the following nominal rates of return.
 
-Refer to Exhibit 1.5. If next year the real rates all rise by 10 percent while inflation climbs from 1.5 percent to 2.5 percent, what will be the nominal rate of return on each security?
A) 1.24% and 1.52% 
B) 1.35% and 3.52% 
C) 3.89% and 6.11% 
D) 3.52% and 3.89% 
E) 1.17% and 6.11%

Quizplus · Accepted Answer

To find the nominal rate of return for each security, we need to use the following formula:
Nominal Rate = (1 + Real Rate) x (1 + Inflation Rate) - 1

For Security A:
Real Rate = 4% - 1.5% = 2.5%
Nominal Rate = (1 + 0.025) x (1 + 0.025) - 1 = 3.89%

For Security B:
Real Rate = 6% - 1.5% = 4.5%
Nominal Rate = (1 + 0.045) x (1 + 0.025) - 1 = 6.11%

Therefore, the correct answer is C.