Question 3:

Suppose that you own a one-year bond indexed by the CPI paying a real interest rate of 4 percent. A 10 percent rise in the CPI that happens to be fully anticipated occurs.

1. You will receive 114.4 percent of the face value of the bond at the end of one year.

2. You will be paid interest at a contracted interest rate of 14 percent because when there is anticipated inflation the market interest rate always equals the real interest rate plus the expected rate of inflation.

3. Because you willingly purchased the bond fully expecting the inflation, the indexing fully compensates you for it.

4. All of the above are true.

Choose the correct option.