Question

Q1) Monique lends Taylor $1,425 on March 15, 2009. Taylor is expected to return $1,539 on March 14, 2010. Monique expects inflation over the one-year period to be 2%. What is the real interest rate that Monique desires? (This is a hard question but the idea is to understand how interest rates are determined.)
6%
3%
8%
10%

Q2) Lonnie lends Burt $14,080 in 2009. Burt's contract requires him to pay Lonnie $176 in real interest over the one-year loan. Lonnie expects inflation over the one-year period to be 1.5%. What nominal interest rate should Lonnie charge Burt? (This is a hard question but the idea is to understand how interest rates are determined.)

0.25%

2.75%

2.5%

–0.25%

QUESTION 33

1. Table: Anticipating Inflation

   Year	Predicted inflation rate	Actual inflation rate
   2000	3%	3%
   2001	3%	2%
   2002	7%	9%
   2003	5%	4%
   2004	4%	7%

   
   
   Using the inflation data in the table above, assume that all loan contracts matured after one year, and that they all had fixed nominal interest rates of 10%. In which of the years given below did lenders gain relative to borrowers?

   		2000
   		2002
   		2003
   		2004

Answer 1

1. Ans: 6%

Explanation:

Nominal interest rate = [(1,539 - 1,425) / 1,425] * 100 = 8%

Inflation rate = 2%

Real interest rate = Nominal interest rate - Inflation rate = 8% - 2% = 6%.

2. Ans: 2.75%

Explanation:

Real interest rate = (176 / 14,080) * 100 = 1.25%

Inflation rate = 1.5%

Nominal interest rate = Real interest rate + Inflation rate = 1.25% + 1.5% = 2.75%

3. Ans: 2003

Explanation:

In the year 2003, the actual inflation rate is less than predicted inflation rate. Therefore, in the year 2003, lenders gain relative to borrowers.