Question

Miguel wants to set up a savings account in order to start saving for a down payment on a car. He has $200 to start his savings account and thereafter plans to save $100 every month. Help Miguel analyze different savings options to determine which savings account is accessible and will earn the most interest. For the following questions, assume that average annual inflation is 2%. To calculate real interest rates adjusted for inflation, use the following simplified equation: Real Interest = Stated (Nominal) Interest - Inflation Rate Miguel first looks at a standard savings account available from a local bank where he has a checking account. It offers an APY of 0.05% and it compounds monthly. What real interest rate can Miguel expect for the standard savings account from his local bank? Do not include the % symbol.

Answer 1

To calculate the real interest rate for the standard savings account, we need to subtract the inflation rate from the stated (nominal) interest rate. In this case, the stated interest rate is 0.05% (APY) and the inflation rate is 2%.

Real Interest Rate = Stated Interest Rate - Inflation Rate

Real Interest Rate = 0.05% - 2% = -1.95%

Therefore, Miguel can expect a real interest rate of -1.95% for the standard savings account from his local bank. Note that a negative real interest rate indicates that the account's returns are not keeping up with inflation, and Miguel's purchasing power will decrease over time.