Question

The rate of inflation as of Thursday is 6 %, this is expected to continue. Sylvia wants to earn a real rate of return of 10% on her

money. The bank is offering her 14% for deposits. a. should Sylvia accept this rate?

Answer 1

To determine whether Sylvia should accept the interest rate offered by the bank, we need to calculate the nominal rate that she would earn on her investment and compare it to the expected real return of 10%.

First, we need to calculate the nominal rate. The nominal rate is the actual rate of return on an investment, including the effect of inflation. To calculate the nominal rate, we can use the formula:

R_n = (1 + R_r)(1 + i) - 1

where

* R_n is the nominal rate of return

* R_r is the inflation rate

* i is the real rate of return

We know that the inflation rate is currently 6% and the real rate of return that Sylvia is seeking is 10%. To calculate the nominal rate, we can rearrange the formula and solve for R_n:

R_n = (1 + R_r)(1 + i) - 1

R_n = (1 + 0.1)(1 + 0.1) - 1

R_n = 0.2 - 1

R_n = -0.8

Since -0.8 is a negative rate, Sylvia would actually be losing money on her investment if she accepted the 14% interest rate. Therefore, she should not accept the offer and look for a better investment opportunity that provides a positive nominal rate of return.

Explanation:

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