With interest rates on the rise, many Americans are wondering what their investm

Question

With interest rates on the rise, many Americans are wondering what their investment strategy should be. A safe (i.e., a virtually risk-free) and increasingly popular way to keep pace with the cost of living is to purchase inflation-indexed government bonds. These so called I-bonds pay competitive interest rates and increase in value when the CPI rises. These bonds can be held for up to 30 years. Suppose you purchased an I-bond for $10,000 and held it for 11 years, at which time you received $20,000 for the bond. Inflation has averaged 4% per year during this 11-year period. What real annual rate of return did you earn on your inflation-adjusted I-bond? Is it really competitive? Historically, real returns have been about 2-3% per year. The real annual rate of return is %. (Round to one decimal place.) Is it really competitive? Choose the correct answer below.

Explanation / Answer

20000 = 10000(1+r)^11 Let 1+r=R

R^11 = 2

R = 1.065

r = 0.065 = 6.5%

real interest rate = r-I = 6.5-4 = 2.5%

Yes this bond is competitive.

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