Question

If investors are to earn a 3.5% real interest rate, what nominal interest rate must they earn if the inflation rate is: (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

		Nominal Interest rate
4.5		%
6.5		%

Answer 1

Sol:

Real interest rate = 3.5%

Inflation rate = 4.5% and 6.5%

i) Inflation rate = 4.5%

(1 + Nominal rate) = (1 + Real rate) * (1 + Inflation rate)

(1 + Nominal rate) = (1 + 3.5%) * (1 + 4.5%)

Nominal rate = (1.035 * 1.045) - 1

Nominal rate = 1.081575 - 1 = 0.81575 or 8.16%

ii) Inflation rate = 6.5%

(1 + Nominal rate) = (1 + Real rate) * (1 + Inflation rate)

(1 + Nominal rate) = (1 + 3.5%) * (1 + 6.5%)

Nominal rate = (1.035 * 1.065) - 1

Nominal rate = 1.102275 - 1 = 0.102275 or 10.23%