Question

Suppose that lenders want to receive a real rate of interest of 5 percent and that they expect inflation to remain steady at 2 percent in the coming years. Based on this, lenders should charge a nominal interest rate of ___________

Answer 1

Answer:

7%

Explanation:

nominal interest rate = real interest rate + expected inflation rate

nominal interest rate = 5% + 2% = 7%

Usually the nominal interest rate has four major components:

1. real interest rate: the net interest rate received by a lender or an investor
2. inflation rate: the general rise in the prices of goods and services, as inflation increases, the purchasing power of a currency decreases
3. liquidity risk premium: usually collateralized loans include a liquidity risk premium since not all assets can be easily converted to cash.
4. credit risk: possibility of the borrower defaulting the loan