Question

1. A nominal interest rate is defined as “the opportunity cost of holding or using money.” Explain what you understand this definition to mean.

Answer 1

The opportunity cost of something is the other this that has to be given up to have the said thing.

For example, if a person has $100 and he can either go to a movie or a concert then the opportunity cost of going to movie would be to forgo the concert.

When a person has money then he can either hold it as cash or put it into interest bearing financial instrument.

If he holds the money as cash then he is losing out on the opportunity to earn interest and therefore interest rate is referred to as the opportunity cost of holding or using money.

Thus.

A nominal interest rate is defined as "the opportunity cost of holding or using money" in the sense that using the money as cash devoid a person of the opportunity to earn interest by putting it into the interest bearing financial instruments.