Given that the inflation rate in 2006 was about 3.24%, while a short-term municipal bond offered a rate of 2.9%, which of the following statements is correct?
A) The purchasing power of investors in these bonds grew over the course of the year.
B) The real interest rate for investors in these bonds was greater than the rate of inflation.
C) Investors in these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.
D) The nominal interest rate offered by these bonds gave the true increase in purchasing power that resulted from investing in these bonds.

Question

Quizplus · Accepted Answer

The real interest rate is calculated by adjusting the nominal interest rate (the rate of return promised by the bond, in this case, 2.9%) for the rate of inflation (3.24%). Since the inflation rate was higher than the interest rate offered by the bonds, the purchasing power of the money invested in these bonds decreased over the year. This means investors could buy less at the end of the year than they could at the beginning, making option C correct.

Given That the Inflation Rate in 2006 Was About 3