Question

5) Assume inflation rate is 0.2% per month. You have two choices A, or B. A) Nominal rate of 0.75% per month, or B) A real rate of 6.5% APR, compounded annually? How much is the superior annual nominal rate given A or B

Answer 1

6.5% APR into monthly return is:

	Periodic interest rate=	(1+Effective annual interest rate)^ 1/m -1
r=	effective annual interest rate	6.5000%
m	number of periods	12
	Periodic interest rate=	(1+0.065)^1/12    -1
	Periodic interest rate=	0.5262%

Options are 0.75% nominal and 0.5262% real

Inflation is 0.2%

Converting given 0.75% nominal into real rate = (1+0.75%)/(1+0.2%) = 0.55%

Nominal rate of 0.75% per month is better as it is providing better returns even in real terms