IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Allowing for inflation
A price index was 200 at the start of year 1, and annual inflation was 5% in year 1 and 8% in year 2. What is the index at the end of year 2?
The index at the end of year 2 is 226.80, found by compounding: 200 x 1.05 x 1.08. Simply adding 5% and 8% gives 226.00, which ignores compounding.
- A226.00
- B226.80Correct
- C228.00
- D230.40
- 216.00
Explanation
Index = 200 x 1.05 x 1.08 = 200 x 1.134 = 226.80. Adding the rates (13%) gives 226.00, which ignores compounding.
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