IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Allowing for inflation
The real effective annual rate of return on a fund is 2% and inflation is 3% per annum. Which of the following is the money effective annual rate, to two decimal places?
The money rate is 5.06%. Multiply the real growth factor 1.02 by the inflation factor 1.03 to get 1.0506. Adding 2% and 3% gives 5%, which ignores the compounding cross term of 0.06%.
- A1.00%
- B5.00%
- C5.06%Correct
- D4.94%
- 6.00%
Explanation
1+i = 1.02 x 1.03 = 1.0506, so i = 5.06%. The 5.00% option adds the rates and ignores the cross term 0.02 x 0.03 = 0.06%.
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