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Chapter 5 - Chapter 5 Answer Key Problem Sets 6 13 16 CFA...

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Chapter 5 – Answer Key: Problem Sets: 6, 13, & 16 CFA Problems: 1, 2, 3, 4, & 5 Problem Sets: 6. a. The “Inflation-Plus” CD is the safer investment because it guarantees the purchasing power of the investment. Using the approximation that the real rate equals the nominal rate minus the inflation rate, the CD provides a real rate of 1.5% regardless of the inflation rate. b. The expected return depends on the expected rate of inflation over the next year. If the expected rate of inflation is less than 3.5% then the conventional CD offers a higher real return than the Inflation-Plus CD; if the expected rate of inflation is greater than 3.5%, then the opposite is true. c. If you expect the rate of inflation to be 3% over the next year, then the conventional CD offers you an expected real rate of return of 2%, which is 0.5% higher than the real rate on the inflation-protected CD. But unless you know that inflation will be 3% with certainty, the conventional CD is also riskier. The
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