the real rate is 2% per year compounded continuously. To pay a fair interest rate to a depositor, the compounding frequency must be at least equal to the frequency of deposits and withdrawals. Only when you compound at least as frequently as transactions in an account can you assure that each dollar will earn the full I. Introduction 5. History of Interest Rates and Risk Premiums The McGraw−Hill Companies, 2001           CHAPTER 5 History of Interest Rates and Risk Premiums 151     interest due for the exact time it has been in the account. These days, online computing for deposits is common, so one expects the frequency of compounding to grow until the use of continuous or at least daily compounding becomes the norm.       SOLUTIONS TO CONCEPT C H E C K S 1. a. 1 R (1 r)(1 i ) (1.03)(1.08) 1.1124 R 11.24% b. 1 R (1.03)(1.10) 1.133 R 13.3% 2. The mean excess return for the period 1926-1934 is 4.5% (below the historical av- erage), and the standard deviation (dividing by n 1) is 30.79% (above the histori- cal average). These results reflect the severe downturn of the great crash and the unusually high volatility of stock returns in this period. 3. r (.12 .13)/1.13 .00885, or .885%. When the inflation rate exceeds the nominal interest rate, the real rate of return is negative.         E-INVESTMENTS: INFLATION AND RATES The text describes the relationship between interest rates and inflation in section 5.1. The Federal Reserve Bank of St. Louis has several sources of information available on inter- est rates and economic conditions. One publication called Monetary Trends contains graphs and tabular information relevant to assess conditions in the capital markets. Go to the most recent edition of Monetary Trends at the following site and answer the follow- ing questions.   http://www.stls.frb.org/docs/publications/mt/mt.pdf