Question

Suppose that the nominal rate of interest is 5% and the expected
rate of inflation is 2%. Whats is the expected real rate of
interest according to Fisher? Calculate the after-tax expected real
rate of assuming a 30% marginal tax rate. If inflation expectations
increase by 2%, what will be the new nominal rate according to
fisher? According to darby/feldstein? What should happen to bond
prices and stock prices if the expected rate of inflation
increase

Answer #1

According to the Fisher effect, the relationship between the nominal interest rate, r, the real interest rate a, and the expected inflation rate, i, is 1 + r = (1 + a)(1 + i).

Substituting in the numbers in the problem yields 1 + r = 1.05/1.02 = 1.0294, or r = 2.94%.

The after tax expected real rate = 2.94%*(1 - 0.30) = 2.06%

If inflation increase by 2%, new inflation be 2% + 2% = 4%

1 + r = (1.0206) (1.04)

r = 6.14%

If there is increase in expected inflation, bond prices will rise and stock prices will fall.

Suppose that the nominal rate of interest is 5% and the current
expected rate of inflation is 2%. If the expected rate of inflation
were to increase by 5% (to a new level of 7%) the nominal rate
would rise to _____ according to the fisher effect and ______
according to the Darby/Feldstein effect. (for the Darby)/Feldstein
effect assume a marginal tax rate of 40%)
a) 6%; 8%
b) 10%;10%
c) 10%;13.33%
d)12%;15.33%

a. What is realised real interest rate? Can a change in expected
inflation rate affect the realised real interest rate? Explain.
b. Suppose that there is an increase in expected inflation rate
from 3 percent to 6 percent. Given that the after-tax expected real
interest rate remains unchanged at 2 percent and the tax rate is 30
percent, find the original and the new nominal interest rates.
c. Suggest ONE way in which investors can reduce/avoid the risk
of unexpected...

Given the nominal interest rate of 13% and the expected
inflation of 15%, then the value of the real interest rate is ___
?
2. With the real interest rate equal to 3% and the expected
inflation equal to 2%, then the value of the nominal interest rate
is___?
3. A lender prefers a (high or lower) real interest rate while a
borrower prefers a (higher or lower) real interest rate higher
lowreal interest rate.

I. The nominal interest rate is 7%. If the
expected inflation is 1% and the risk premium equals 2%, then what
does the risk-free rate equal?
II. The nominal risk-free rate is 7% and the
real rate of interest is 3%; then what is the expected inflation is
expected to be?

Suppose the one year nominal interest rate is 3 percent and that
the expected inflation is equal to 4 percent. The price index over
this one year period went from 218 to 223. Compare the ex-ante real
rate of interest to the ex-post real rate of interest. Which real
rate of interest would you more likely be willing to spend today
and which real rate of interest would you more likely be willing to
save and why?

If the nominal interest rate is 3.8 percent, and the real
interest rate is 2.0 percent, then using the Fisher Equation, the
expected inflation must be _______

Suppose that the nominal risk-free rate of interest is 2.75%,
and that of Russia is 5%. The inflation rate in Russia is 3.25%,
what is the inflation rate in US? Use the equation for the
International Fisher effect

Use the Fisher Effect to find the answer the following
questions.
a. Nominal interest rate = 9%, real interest rate = 5%, what is
inflation?
b. Nominal interest rate = 8%, inflation = 3%, what is the real
interest rate?
c. Real interest rate = 6%, inflation = 2%, what is the nominal
interest rate?

. In an excel spreadsheet, calculate the real interest rate over
the past 24 months (using monthly data) for the 30 year Treasury
bond rate as the nominal interest rate and assuming that expected
inflation was equal to actual inflation (based on the change in
CPI). Make sure to include the Fisher Equation

According to the Fisher effect, if inflation rises then the
nominal interest rate rises.
Select one:
True
False

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