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

Answer:

2.45339%

Explanation:

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

$\frac{(1+rate)}{(1+inflation)}-1= real \: rate$

$\frac{(1+0.044)}{(1+inflation)}-1= 0.019 \: rate$

$\frac{(1.044)}{(1+inflation)}= 1.019 \: rate$

$\frac{(1.044)}{(1.019)}= 1+inflation \: rate$

$\frac{(1.044)}{(1.019)} -1 = inflation \: rate$

inflation = 0.0245338565 = 2.45339%