Four fundamental factors affect the cost of money: (1) the return that borrowers expect to earn on their investments, (2) the preference of savers to spend their income in the current period rather than delay their consumption until some future period, (3) the risks associated with the investment, and (4) expected inflation. Consider the following statements that address these factors, and indicate which you think are true. Statement 1: All things being equal, savers and investors expect to receive some amount of maturity premium as compensation for their deferred consumption.
Statement 2: Historical inflation rates, as opposed to expected future rates of inflation, should be used when calculating an investment’s nominal risk-free rate of return.
Statement 3: An investment that can provide a 10% return should attract more investment capital than an otherwise identical investment that can only provide a 6% return.
Statement 4: The inflation premium used to calculate the nominal interest rate on a five-year security should be equal to the rate of inflation expected in year 5 of the investment.
The true statements are:.
a. 1, 2, 3, and 4
b. 2 and 4
c. 1, 2, and 3
d. 1 and 3