13) In which of the following situations would you prefer to be the lender? 13) A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 13 percent and the expected inflation rate is 15 percent. C) The interest rate is 4 percent and the expected inflation rate is 1 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent

C) The interest rate is 4 percent and the expected inflation rate is 1 percent.

Explanation:

Generally, a person would prefer to be a lender when the interest rate is higher than the expected inflation. The idea is to compensate the lender that fall in the value of money that will occur as a result of the fall in the value of money caused by the expected inflation. From the question, only situations (A) and (C) meet these criteria. But we have to choose one based on the criteria in the next paragraph.

Specifically, if a person is confronted with more than one situation to a be lender, he will prefer to be a lender under a situation where the weight of contribution of interest rate to the addition of interest and expected inflation is the highest. Given only (A) and (C) meet the first criteria, we can compute the weight of contribution of interest rate as follows:

For situation (A) - Weight of interest rate contribution = [9% * (9% + 7%) ] = 0.56, or 56%

For situation (C) - Weight of interest rate contribution = [4% * (4% + 1%) ] = 0.80, or 80%

Situation (C) 's weight of interest rate contribution of 80% is higher than the situation (A) 's weight of interest rate contribution of 56%, the person will prefer to be a lender under situation (C) where the interest rate is 4 percent and the expected inflation rate is 1 percent.