Which is the safer investment? Can you tell which offers the higher expected return? If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? If we observe a risk-free nominal interest rate of 5% per year and a risk-free real rate of 1.5% on inflation-indexed bonds, can we infer that the market's expected rate of inflation is 3.5% per year?
Which is the safer investment? Can you tell which offers the higher expected return? If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? If we observe a risk-free nominal interest rate of 5% per year and a risk-free real rate of 1.5% on inflation-indexed bonds, can we infer that the market's expected rate of inflation is 3.5% per year?
Chapter7: Unemployment And Inflation
Section: Chapter Questions
Problem 7E
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u are considering the choice between investing $50,000 in a conventional 1-year bank CD offering an interest rate of 5% and a 1-year Inflation-Plus CD offering 1.5% per year plus the rate of inflation.
- Which is the safer investment?
- Can you tell which offers the higher expected return?
- If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why?
- If we observe a risk-free nominal interest rate of 5% per year and a risk-free real rate of 1.5% on inflation-indexed bonds, can we infer that the market's expected rate of inflation is 3.5% per year?
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Step 1: Introduce the concept of Certificate of Deposit (CD).
VIEWStep 2: 1. Determine which is the safer investment.
VIEWStep 3: 2. Determine which offers the higher expected return.
VIEWStep 4: 3. Determine which is the better investment if the rate of inflation to be 3% over the next year.
VIEWStep 5: 4. Determine the market's expected rate of inflation
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