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: On average and everything else held constant, it is generally assumed that savers and investors prefer immediate consumption to deferred, or postponed, spending.
Statement 2: Investments providing cash flows that are more likely to equal their expected value are said to exhibit more risk.
Statement 3: The onset of 5% inflation means that your receipt of a $100 interest payment allows you to purchase only $95 worth of goods and services.
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 and 4
b. 2 and 4
c. 1 and 3
d. 2 and 3

c. 1 and 3

Explanation:

1. Even though Investors and Savers forego their immediate consumption for future consumption, it is generally assumed that both groups actually prefer immediate consumption to deferred consumption.

This is why they are offered a rate of return that compensates them enough to convince them to take deferred consumption over current consumption.

3. When inflation rises, it erodes the value of money such that people are able to buy less goods using the same amount of money as they were able to before.

If you therefore receive a payment of $100 and inflation is 5%, then 5% of the value of that $100 has been eroded which is $5. This means you're only able to buy $95 worth of goods and services.

it should be

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