Suppose You Have $1,000, Which You Can Put in Two

question 88

Essay

Suppose you have $1,000, which you can put in two different types of accounts at a bank. One account pays interest of 9 percent per year; the other pays an interest rate of 3 percent per year plus the rate of inflation. Calculate the amount of money you will have at the end of one year if the inflation rate is 5 percent. What is the real rate of return in each case? Which account would you prefer if you expected inflation to be 8 percent?

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Definitions:

Growing Annuity

A financial term that refers to a series of cash flows or payments that grow at a fixed rate per period.

Required Rate

Required Rate, or the minimum expected rate of return on an investment, reflects the investor's risk tolerance and investment criteria.

Cash Flow Growth

The increase in the amount of cash that a company generates over time.

Growing Annuity

A sequence of financial transactions increasing at a steady rate over a limited duration.