A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

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BlackTom AI · Accepted Answer

The question asks for the approximate annual real rate of return when you earn 5% nominal interest and inflation is 3.5%. To compare, we use the approximate real rate formula: real ≈ nominal − inflation, but a more precise approach is (1 + nominal) / (1 + inflation) − 1.
Option 1: 1.5%. If we compute the exact real rate using (1 + 0.05) / (1 + 0.035) − 1, we get about (1.05 / 1.035) − 1 ≈ 1.01449 − 1 ≈ 0.01449, or 1.45%, which rounds to about 1.5%. This is a good approximate value.
Option 2: 10%. This would imply a real gain far larger than the nominal minus inflation calculation; it ignores the inflation drag and is not consistent with the given rates.
Option 3: 7%. Similar to option 2, this overstates the real return by not accounting for the 3.5% inflation to chip away at the nominal return.
Option 4: 3%. This corresponds to a naive nominal minus inflation calculation (5% − 3.5% = 1.5%), but interpreting 3% as real return is inaccurate because the precise real rate is around 1.45%, not 3%.
Option 5: None of the options. Since the calculated real return is about 1.45%, which is closest to 1.5%, at least one option matches the result, so this choice is not correct.
In summary, the closest and numerically accurate choice given the numbers is the 1.5% option, arising from adjusting the 5% nominal return for 3.5% inflation using the standard real rate calculation.

BFF3121 - S2 2025 Chapter 5 Review Quiz

A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

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BFF3121 - S2 2025 Chapter 5 Review Quiz

A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

View Explanation

Log in for full answers

Similar Questions

If the nominal interest rate is equal to 5%, and the inflation rate is equal to -5%, then what is the real interest rate?

Part 1Suppose you postpone consumption and invest at​ 6% when inflation is​ 2%. What is the approximate real rate of your reward for​ saving? Part 1 A. ​4% B. ​3% C. ​5% D. ​6%

Suppose you put $100 in the bank on January 1, 2017. If the annual nominal interest rate is 10 percent and the inflation rate is 5 percent, the real interest rate is ______ percent.

You deposited your holiday bonus in your bank account on January 1, 2024. If the annual nominal interest rate is 4.3 percent and the inflation rate is 2.0 percent, you will earn ______ percent in real terms. Round your answer to the nearest tenth of a percent.

Finally, inflation rises to 6.5 percent and your bank adjusts the interest rate to 12.5 percent to maintain the same pre-tax interest rate (according to the Fisher equation). Calculate your real after-tax rate of return (in percent). Round your answer to the nearest tenth of a percent.

Suppose that you deposit money in your bank account on January 1, 2023. The annual nominal interest rate is 6.0 percent and the inflation rate is 3.3 percent. Your one-year real rate of return is ________ percent. Round your answer to the nearest tenth of a percent.

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Part 1Suppose you postpone consumption and invest at 6% when inflation is 2%. What is the approximate real rate of your reward for saving? Part 1 A. 4% B. 3% C. 5% D. 6%