An investor wants to be able to buy 4 percent more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2 percent. Which statement(s)below is/are true?
I. 4 percent is the desired real risk-free interest rate.
II. 6 percent is the approximate nominal rate of interest required.
III. 2 percent is the expected inflation rate over the period.

Question

Quizplus · Accepted Answer

The investor wants a real increase in purchasing power of 4%, which is the desired real risk-free interest rate (I). With expected inflation at 2% (III), the nominal rate needed to achieve this real increase, using the approximation formula (1 + real rate) * (1 + inflation rate) - 1, is about 6% (II).

An Investor Wants to Be Able to Buy 4 Percent