You are considering two investments, a conventional, FDIC insured 1-year bank CD with an interest rate of 5% and a 1-year “Inflation Plus” CD offering 1.5% plus the rate of inflation, which is also FDIC insured.
a. Which investment is safer?
b. If you expect inflation to be 3% over the coming year, which investment would be better? Explain.
c. If we observe a nominal risk free rate of 5% and a real rate of 1.5% on inflation-indexed bonds, can we infer that the markets expected rate of inflation is approximately 3.5%?