You are considering the choice between investing $50,000 in a conventional 1-year bank CD offering an interest...

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Finance

You are considering the choice between investing $50,000 in aconventional 1-year bank CD
offering an interest rate of 5% and a 1-year “Inflation-Plus” CDoffering 1.5% per year plus the
rate of inflation.
a. Which is the safer investment?
b. Can you tell which offers the higher expected return?
c. If you expect the rate of inflation to be 3% over the next year,which is the better investment? Why?
d. If we observe a risk-free nominal interest rate of 5% per yearand a risk-free real rate of 1.5% on
inflation-indexed bonds, can we infer that the market’s expectedrate of inflation is 3.5% per year?

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4.3 Ratings (521 Votes)

Part a Inflation plus CD is safer investment because it takes care of inflation part ensuring real rate of return constant Part b Without ascertaining the See Answer

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Transcribed Image Text

You are considering the choice between investing $50,000 in aconventional 1-year bank CDoffering an interest rate of 5% and a 1-year “Inflation-Plus” CDoffering 1.5% per year plus therate of inflation.a. Which is the safer investment?b. Can you tell which offers the higher expected return?c. If you expect the rate of inflation to be 3% over the next year,which is the better investment? Why?d. If we observe a risk-free nominal interest rate of 5% per yearand a risk-free real rate of 1.5% oninflation-indexed bonds, can we infer that the market’s expectedrate of inflation is 3.5% per year?