Question

Pretend that you’re a money lender. The nominal amount of interest you get on a loan you made to someone else is 5%. The rate of inflation during the year that you’ve made the loan is 3%. What is the real interest rate on your loan? Explain intuitively the difference between the nominal and real interest rate.

Answer #1

Real interest rate = Nominal interest rate - Inflation rate

= 5% - 3%

= 2%

Thus, the real interest rate on your loan is 2%.

A real interest rate is adjusted to remove the effects of inflation, which reflects the real cost of funds to the borrower and real return to the lender.

On the other hand, a nominal interest rate refers to an interest rate that does not remove inflation.

Suppose that a borrower and a lender agree on the nominal
interest rate to be paid on a loan. Then inflation turns out to be
lower than they both expected.
(1) True or False: The real interest rate on
this loan is lower than expected.
The lender (2) gains/loses from this unexpected
lower inflation, and the borrower
(3) gains/loses under these circumstances.
Inflation during the 1970s was much higher than most people had
expected when the decade began.
Homeowners who...

Boris Borrower and Lynn Lender agree that Lynn will lend Boris
$10,000 and that Boris will repay the $10,000 with interest in one
year. They agree to a nominal interest rate of 8%, reflecting a
real interest rate of 3% on the loan and a commonly shared expected
inflation rate of 5% over the next year.
Assume that there is a fall of 2 percentage points in the
expected future inflation rate. How will the real interest
rate be affected...

3. Distinction Between Real and Nominal Interest Rates
a. Distinguish between a nominal versus a real interest
rate.
b. If a bond gives you a 4% nominal annual interest rate and the
inflation rate over the year is 2%, what is the real ex post rate
of return you receive? Real Rate You Receive _______________
c. If an investor wants a real rate of return of 2% and expects
inflation to be 2% next year, what nominal rate should the...

Describe the difference between nominal
and real interest rates. Calculate the missing value in each of the
following scenarios:
Expected inflation is 4% and the nominal interest rate is 6%,
what is the real interest rate?
The real interest rate is 2% and the nominal interest rate is
3%, what is expected inflation?
Expected inflation is -1% and the real interest rate is 1%, what
is the nominal interest rate?

Assume you are borrowing money from a car dealer today to
purchase a new car. It is expected that inflation will average 3%
per year over the next five years – the life of the car loan. This
inflation expectation has been built into the interest rate you are
being charged on the five-year, fixed interest rate car loan – the
rate, and therefore your monthly payment, cannot be changed. Based
on the facts above, it will benefit the lender...

6. Suppose you walk into a bank to borrow money for a new car.
The loan officer tells you that they will loan you $10,000 for the
car at a simple interest rate of 5.3 percent per year. You must
repay the loan at the end of the year.
a) How much interest will you have to
pay?
b) The bank expects that the inflation
rate will be 2.2 percent over the year. What does the bank think
that the...

Boris Borrower and Lynn Lender agree that Lynn will lend Boris
$10,000 and that Boris will repay the $10,000 with interest in one
year. They agree to a nominal interest rate of 8%, reflecting a
real interest rate of 3% on the loan and a commonly shared expected
inflation rate of 5% over the next year.
If the inflation rate is actually 6% over the next year, how
does that lower-than-expected inflation rate affect Boris and Lynn?
Who is better...

Please explain the difference between the nominal and real
interest rate in the short-run and the long-run. How and why does
the quantity theory help us understand the relationship between the
money supply, interest rates and inflation? How and why are nominal
interest rates so low in the U.S. today? Please all the tools at
your disposal to demonstrate your understanding of the market
today.

You are told that the nominal interest rates in Country A is
14%, and the nominal interest rates in Country B is 8 %. Economists
estimate that the real interest rate is 2% per year in both
countries.
a) What would you expect inflation to be in Country A and
Country B?
b) If the exchange rate adjusts to keep the real prices of goods
the same in the two countries, how would the exchange rate between
Country A and...

In the country of Wiknam, the velocity of money is constant.
Real GDP grows by 5 percent per year, the money stock grows by 14
percent per year, the nominal interest rate is 11 percent and the
real interest rate is 2%
1. In Wiknam if Real GDP growth slows what would you expect to
happen to the inflation rate? Explain using the model why.
2. If Wiknam households expect higher inflation in the coming
year, how might that effect...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 3 minutes ago

asked 23 minutes ago

asked 29 minutes ago

asked 42 minutes ago

asked 42 minutes ago

asked 50 minutes ago

asked 50 minutes ago

asked 53 minutes ago

asked 56 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago