Question

Assume that the real rate of interest is 5 percent and a lender charges a nominal interest rate of 15 percent. If a borrower expects that the rate of inflation next year will be 10 percent and the actual rate of inflation next year is 12 percent:__________.1. neither the borrower nor the lender benefits from inflation.2. both the borrower and the lender lose from inflation.3. the borrower benefits from inflation, while the lender loses from inflation.4. the lender benefits from inflation, while the borrower loses from inflation.

Answer 1

Answer:

.3. the borrower benefits from inflation, while the lender loses from inflation.

Explanation:

Expected inflation rate = Nominal interest rate - Real interest rate

15% - 5% = 10%

So the percentage of expected inflation inherent in the interest rate is 10%.

Both parties expect inflation rate to be 10% but inflation rate is 12%.

This means that the borrower has paid less. The value of money the lender would be receiving the following year would be less than value of money in the following year due to the higher inflation rate than anticipated. Therefore the borrower gains and the lender losses.

I hope my answer helps you