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3 July, 04:36

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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  1. 3 July, 07:05
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    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
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