Question

Assume one investor bought a 10-year inflation-protected bond with a fixed annual real rate of 1.5% and another investor bought a 10-year bond without inflation protection with a nominal annual return of 4.2%. If inflation over the 10-year period averaged 2 percent, which investor earned a higher real return?

A. The investor who purchased the inflation protected bond.
B. The investor who purchased the bond without inflation protection.
C. Both investors earned the same real return.
D. Neither investor earned a positive real return.

Answer 1

B. The investor who purchased the bond without inflation protection.

Step-by-step explanation:

According to fisher, is necessary to calculate the real interest rate of both options for a comparision. The formula is defined as follows:

Real interest rate = nominal rate - inflation

Investor A

1.5% annual rate of interest

There is no inflation to be calculated because the bond is inflation-protected.

Real interest rate = 1.5% - 0 = 1.5%

Investor B

4.2% annual rate of interest

2% average inflation

Real interest rate = 4.2% - 2% = 2.2%

In conclusion, the investor without inflation protection earns a higher real return