Everyone uses money, and it is important to understand what factors affect the c

Question

Everyone uses money, and it is important to understand what factors affect the cost of money. Consider the following scenario: Due to recent political and economic events, general prices of goods and services are expected to increase significantly over the next five years. You were about to purchase a five-year bond. You now require a higher return on the bond than you did before you found out about these expected price increases. Determine which of these fundamental factors is affecting the cost of money in the scenario described

Explanation / Answer

Inflation

Nominal rate of return = Real rate of return + Inflation rate

Now, to maintain the real rate of return, one has to expect higher rate of nominal rate of return due to expected inflation rate.

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