Exercises: Nominal and Real Interest Rates
A bank offers a loan at a nominal interest rate of 6% when expected inflation is 2%. Compute the expected real interest rate. Write the formula you use.
A bank offers a loan at a nominal interest rate of 6% when expected inflation is 2%. Compute the expected real interest rate. Write the formula you use.
Define the nominal interest rate and the real interest rate. Which one tells a lender how much purchasing power she gains from lending, and why?
Define the nominal interest rate and the real interest rate. Which one tells a lender how much purchasing power she gains from lending, and why?
Rank a savings account, a corporate bond, and a stock index fund from lowest to highest in typical risk and in typical expected return. Explain in one sentence what it…
Rank a savings account, a corporate bond, and a stock index fund from lowest to highest in typical risk and in typical expected return. Explain in one sentence what it means for an asset to be liquid, and say which of the three is the most liquid.
A loan carries a nominal interest rate of 9%. When it was made, borrower and lender expected inflation of 3%. Actual inflation turned out to be 5%. Compute the expected…
A loan carries a nominal interest rate of 9%. When it was made, borrower and lender expected inflation of 3%. Actual inflation turned out to be 5%. Compute the expected real interest rate and the actual real interest rate. Who benefited from the difference?
An economy has the following data. | Year | Nominal rate | Inflation rate | |---|---|---| | 1 | 5% | 3% | | 2 | 4% | 4.5% | | 3 | 3% | $-1\%$ | Compute the real interest…
An economy has the following data.
| Year | Nominal rate | Inflation rate |
|---|---|---|
| 1 | 5% | 3% |
| 2 | 4% | 4.5% |
| 3 | 3% | $-1\%$ |
Compute the real interest rate in each year. In which year do lenders lose purchasing power, and what does the result for year 3 show about deflation?
Emma has $\$10{,}000…
Emma has $\$10{,}000$ that she will need in two years for a car. She is comparing a bank CD earning 3% (FDIC insured), a corporate bond earning 5%, and a stock index fund with an average long-run return of 8% that can lose value in any given year. Expected inflation is 2.5%. Compute the approximate expected real return on each option. Then argue which she should choose, using the ideas of risk, return, and liquidity.
A bond pays a fixed $\$50…
A bond pays a fixed $\$50$ per year forever (a perpetuity), and its price equals the annual payment divided by the market interest rate. (a) Compute its price when the market rate is 5%. (b) Compute its price when the market rate rises to 6.25%. (c) Compute the percent change in the price. (d) Explain the general relationship between bond prices and interest rates, and explain who bears the risk when interest rates rise, the investor who holds the bond or the one who is about to buy it.
An economy's nominal interest rate is 5% and expected inflation is 2%. Then households and firms come to expect inflation of 4%. (a) Compute the real rate before the…
An economy's nominal interest rate is 5% and expected inflation is 2%. Then households and firms come to expect inflation of 4%. (a) Compute the real rate before the change and the real rate after the change, if the nominal rate stays at 5%. (b) Describe the effect on borrowing, investment, and aggregate demand in that case. (c) Now suppose lenders fully adjust, and the nominal rate rises to 7%. Compute the real rate, and explain the Fisher effect that this illustrates. (d) Explain why unexpected inflation can redistribute income between borrowers and lenders but fully expected inflation generally does not.