Which of the following statements is TRUE? A) You can always earn a high rate of

Question

Which of the following statements is TRUE?

A) You can always earn a high rate of return by purchasing zero-coupon bonds at a premium

B) Lenders want to protect their purchasing power reward from being wiped out by lower inflation

C) The Fisher Effect indicates that for a given nominal rate, higher inflation would result in a lower real rate

D) We can find the nominal interest rate by subcontracting the default and maturity premiums from the sum real rate and inflation

Please tell me why the other 3 answers are false

Explanation / Answer

C) is correct, because as per Fisher Effect, Real rate = Nominal rate - inflation rate.

A) is wrong because zero-Coupon bonds are issued at a discount since they dont pay the interest (coupon payments), if you are buying them at a premium, you are paying more than the fair value and thus lowering your rate of return.

B) is wrong because lenders are worried about higher inflation rather than lower inflation, since higher inflation would reduce your purchasing power.

D) is wrong because the correct formula for finding the nominal interest rates is;

Nominal rate = Real rate + Inflation rate.

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