Suppose you bought an inflation-indexed security for $12,000 in January 2013 which pays an annual interest of 4 percent.If the value of the inflation index in January 2013 was 106 and its value in January 2014 was 105, what is the value of the inflation-adjusted principal?
A)$12,114.29
B)$11,342.58
C)$8,000.60
D)$13,126.41

Question

Suppose you bought an inflation-indexed security for $12,000 in January 2013 which pays an annual interest of 4 percent.If the value of the inflation index in January 2013 was 106 and its value in January 2014 was 105, what is the value of the inflation-adjusted principal?
A)$12,114.29
B)​$11,342.58
C)​$8,000.60
D)​$13,126.41

Quizplus · Accepted Answer

The inflation-adjusted principal is calculated by adjusting the original principal amount according to the change in the inflation index. Since the inflation index decreased from 106 to 105, this indicates deflation rather than inflation. However, inflation-indexed securities typically have a feature that protects the principal from deflation, meaning the principal amount cannot decrease below its original value due to deflation. Therefore, the principal remains $12,000, and the interest for one year at 4% is $480 ($12,000 * 0.04). The total value, without adjusting for a decrease in the inflation index (since the principal does not decrease in value), is $12,480. However, none of the provided options match this calculation directly, suggesting a misunderstanding in the calculation process or a misinterpretation of the options. Given the options and the context, the correct approach to find the inflation-adjusted principal would involve understanding that the principal does not decrease but rather the interest calculation might be considered in the context of the options provided. The correct answer, based on the options and understanding that the principal should not decrease due to deflation, seems to be a misunderstanding in the explanation process, as none of the options directly reflect the simple interest calculation provided. The correct calculation should consider the adjustment based on the inflation rate, but with the given decrease in the inflation index, the principal's adjustment would not decrease it below its original amount. The correct answer, considering the misunderstanding, should reflect the original principal plus any adjustments for inflation, but in this case, the adjustment does not decrease the principal. The explanation mistakenly calculates simple interest without directly addressing the inflation adjustment as per the options provided.

Suppose You Bought an Inflation-Indexed Security for $12,000 in January