Question

If the annual real rate on a 10-year inflation-protected bond equals 1.9 percent and the annual nominal rate of return on a 10-year bond without inflation protection is 4.4 percent, what average rate of inflation over the ten years would make holders of inflation-protected bonds and holders of bonds without inflation protection equally well off?

Answer 1

2.45339%

Step-by-step explanation:

we haveto use thwe fisher formula to calculate which inflation makes a 4.4% nominal rate equalto 1.9% real rate:

`((1+rate))/((1+inflation))-1= real \: rate`

`((1+0.044))/((1+inflation))-1= 0.019 \: rate`

`((1.044))/((1+inflation))= 1.019 \: rate`

`((1.044))/((1.019))= 1+inflation \: rate`

`((1.044))/((1.019)) -1 = inflation \: rate`

inflation = 0.0245338565 = 2.45339%