Suppose you have $1,000, which you can put in two different types of accounts at a bank. One account pays interest of 8 percent per year; the other pays interest of 2 percent per year plus the rate of inflation. Calculate the real return you will receive after one year if the inflation rate is 5 percent. Which account will you choose if you expect the rate of inflation to be 8 percent? Why?

Question

Macdonald

Business

27 August, 10:20

Suppose you have $1,000, which you can put in two different types of accounts at a bank. One account pays interest of 8 percent per year; the other pays interest of 2 percent per year plus the rate of inflation. Calculate the real return you will receive after one year if the inflation rate is 5 percent. Which account will you choose if you expect the rate of inflation to be 8 percent? Why?

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Answers (1)

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Porky · Answer 1

In both cases the second bank offers better conditions.

Explanation:

Giving the following information:

Suppose you have $1,000, which you can put in two different types of accounts at a bank.

We need to use the following formula:

FV = PV * (1+i) ^n

A) Interest rate = 8%

i) inflation = 5%

i = 8 - 5 = 3%

FV = 1000 * (1.03) = $1030

ii) Inflation = 8%

i = 0%

FV = 1000

B) Interest = 2% + inflation

i) i = 7%

FV = 1000*1.07=1070

ii) i = 10%

FV = 1000*1.10 = 1100