IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Allowing for inflation
An investor in Pune requires a real effective annual return of 3% when inflation is expected to run at 6% per annum. What money effective annual rate of interest must the investment earn, to two decimal places?
The required money rate is 9.18%. Multiply one plus the real rate by one plus the inflation rate: 1.03 x 1.06 = 1.0918. Adding 3% and 6% to get 9% omits the cross-product term of 0.18%, so it understates the required return.
- A9.00%
- B9.18%Correct
- C8.82%
- D3.00%
- 9.55%
Explanation
The money rate satisfies 1+i = (1+r)(1+e) = 1.03 x 1.06 = 1.0918, so i = 9.18%. The 9.00% option simply adds the rates and misses the cross term 0.03 x 0.06 = 0.0018.
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