Explanation:
The real rate of interest is calculated by subtracting the inflation rate from the nominal interest rate. In this case, the nominal interest rate is 3% and the inflation rate is 4%. Therefore, the real rate of interest is 3% - 4% = -1%. This means that the purchasing power of the investor is reduced by 1%. When an investor earns a return of 3%, it is not enough to keep up with the inflation rate of 4%. As a result, the investor's purchasing power decreases by 1%.
Choice B is incorrect. The purchasing power of the investor would not be reduced by 5%. This would only be the case if the inflation rate was significantly higher than it is, or if the return on investment was significantly lower.
Choice C is incorrect. The purchasing power of the investor does not increase in this scenario. In fact, it decreases because the return on investment (3%) is less than the inflation rate (4%).
Choice D is incorrect. The purchasing power of an investor would not decrease by 7%. This percentage decrease in purchasing power would require a much higher inflation rate or a much lower return on investment than what has been given in this scenario.
Q.3827 In a given market, the nominal rate of interest is 3% and the estimated inflation rate is 4%. Which of the following statements is correct regarding the market?
A
When an investor earns a return of 3%, the purchasing power of the investor is reduced by 1%.
B
When an investor earns a return of 3%, the purchasing power of the investor is reduced by 5%.
C
When an investor earns a return of 3%, the purchasing power of the investor is increased by 1%.
D
When an investor earns a return of 3%, the purchasing power of the investor is reduced by 7%.
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