Question

Treasury bills are currently paying 7 percent and the inflation rate is 3.2 percent. a. What is the approximate real rate of interest? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the exact real rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

The real risk free rate is 3.8%

The exact risk-free rate is 3.68%

Explanation:

The interest rate on the Treasury bills is usually a combination of real risk free rate and inflation rate to compensate investors for average inflation in the economy during the instrument lifetime which equals nominal risk-free rate.

nominal risk-free rate = real risk-free rate+inflation rate

nominal risk-free rate=7%

inflation rate=3.2%

real risk-free rate=7%-3.2%

real risk-free rate=3.8%

The exact real risk-free rate can be computed thus:

nominal rate+1=(real risk-free rate+1)*(inflation rate+1)

real risk-free rate=(nominal rate+1)/(inflation rate+1)-1

real risk free rate=(1.07/1.032)-1

real risk-free rate=0.036821705

real risk-free rate=3.68%