Elizabeth is seeking to expand her rare coin collection. Each year, rare coins increase in price at a three percent rate. She believes that if she invests her money for one year, she should be able to buy 26 coins for what 25 coins would cost today
What is the approximate nominal rate necessary to compensate for waiting and to cover inflation?
A) 7.00%
B) 6.50%
C) 6.00%
D) 5.00%
Answer: A
Explanation: A) The inflation rate is 3.00%. The real rate is given by - 1 where FV = 26, PV = 25 and n = 1. We have: real rate - 1 = 0.04 or 4.00%.
Nominal rate = real rate + inflation = 3.00% + 4.00% = 7.00%, which is the rate necessary to compensate her for waiting and to cover inflation.
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