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nasty-shy [4]
4 years ago
10

Suppose Sally borrows $1,000 from Harry for one year and agrees to pay a nominal interest rate of 8%. When she borrows the money

, both she and Harry expect an inflation rate of 6%.
1. The expected real interest rate on the loan is_______%.
2. Suppose that when Sally pays back the loan after one year, the actual inflation rate turns out to be 4%. The actual real interest rate on the loan is______%.
3A. If the inflation rate turned out to be higher than expected, then_______.
3B. But if inflation turned out to be lower than expected, then_______.
Business
1 answer:
Yuliya22 [10]4 years ago
4 0

Answer:

1.  1,89%

2. 3,85%

3A. A Lower real rate will be obtained, and Harry is in worse off position

3A. A Higher real rate will be obtained, and Harry is in better off position

Explanation:

Real Interest Rate is the <em>Nominal Return </em>that has been adjusted with the Inflation rate.

The effect of the inflation is to reduce the value of money over time.

If Inflation rate was 6%

Real Interest Rate = ( 1 + nominal return) / (1 + Inflation rate) - 1

                              = ( 1 + 0.08) / ( 1 + 0.06) - 1

                              = 0.0189 or 1,89%

If Inflation rate was 4%

Real Interest Rate = ( 1 + nominal return) / (1 + Inflation rate) - 1

                              = ( 1 + 0.08) / ( 1 + 0.04) - 1

                              = 0.0385 or 3,85%

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