Question

The two-year interest rate is 10% and the expected annual inflation rate is 5%.

Answer 1

In economics, the Fisher equation is used to determine the relationship of the nominal interest rate and the real interest rate. This equation takes into account the effect of inflation. Mathematically this is expressed as:

Real rate = $\frac{1+Nominal rate}{1+Inflation}$ -1

The values given are:

Nominal rate= 10% = 0.1

Inflation=5%=0.05

Substituting known values and by calculation:

Real rate=0.0476 = 4.76%