Question

Please Answer all, Thank you !

Imagine you borrow $500 from your roommate, agreeing to pay her back $500 plus 12 percent nominal interest in one year. Assume inflation over the life of the contract is expected to be 5.92 percent. What is the total dollar amount you will have to pay her back in a year? What approximate percentage of the interest payment is the result of the real rate of interest?

1. Total Dollar Amount:

2.

Approximate percentage of interest attributable to the real rate of interest:

If the nominal rate of interest is 4.30 percent and the expected rate of inflation is 1.82 percent, what is the real rate of interest?

3. Real Rate of Interest:

Answer 1

1 Total dollar amount repayable in 1 year = Principal + interest = 500 + 500 x 12% = $ 560

2. Nominal rate = 12%

Inflation = 5.92%

Approximate percentage of the interest payment is the result of the real rate of interest = Nominal rate - inflation

Approximate percentage of the interest payment is the result of the real rate of interest = 12% - 5.92% = 6.08%

3.

Nominal rate = 4.30%

Inflation = 1.82%

Real Rate = (1 + Nominal rate) / (1 + inflation) - 1 = 2.4357%

{Note that in question 2, we calculated real rate as nominal rate - inflation. This is because question asks for approximate real interest rate)