How much interest will Michael earn on his Certificate of Deposit in the first year, considering the real interest rate?

To determine how much interest Michael will earn on his Certificate of Deposit (CD) in the first year considering the real interest rate, it is important to understand the concept of real interest rates and how they affect the yield on investments such as CDs.

The real interest rate is the nominal interest rate adjusted for inflation, reflecting the true purchasing power of the interest earned. If the nominal interest rate on the CD is 4%, for example, and the inflation rate is 2%, the real interest rate would be 2%. This means that the increase in purchasing power from the interest earned on the CD is effectively 2%.

In practice, if we apply this understanding to the provided choices, it suggests that the calculation of interest should yield results that correspond to this concept. If, for instance, Michael's principal in the CD is $10,000 and the nominal interest rate is 4% for the first year, the interest earned would be calculated as:

Interest = Principal × Nominal Interest Rate

Interest = $10,000 × 0.04

Interest = $400

Given that the choice of $200 would imply a significantly lower interest rate or principal amount, it indicates that the correct understanding of the real interest earned is not being met