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You are considering the choice between investing $50,000 in aconventional 1-year bank CDoffering an interest rate of 5% and a 1-year “Inflation-Plus” CDoffering 1.5% per year plus therate of inflation.a. Which is the safer investment?b. Can you tell which offers the higher expected return?c. If you expect the rate of inflation to be 3% over the next year,which is the better investment? Why?d. If we observe a risk-free nominal interest rate of 5% per yearand a risk-free real rate of 1.5% oninflation-indexed bonds, can we infer that the market’s expectedrate of inflation is 3.5% per year?
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