If the current inflation rate is 4% and you have an investment opportunity that pays 10%,then the real rate of interest on your investment is closest to:
A)10.0%
B)14.0%
C)6.0%
D)5.8%
E)4.0%

Question

Quizplus · Accepted Answer

The real rate of interest is the nominal rate minus the inflation rate. Therefore, the real rate of interest on this investment would be 10% - 4% = 6%. However, this does not take into account the compounding effect of inflation. To adjust for this, we use the following formula:

Real Rate = (1 + Nominal Rate) / (1 + Inflation Rate) - 1

Plugging in the numbers, we get:

Real Rate = (1 + 0.10) / (1 + 0.04) - 1
Real Rate = 1.058 - 1
Real Rate = 0.058 or 5.8%

Therefore, the best choice is D) 5.8%.

If the Current Inflation Rate Is 4% and You Have