Problem 1 (related to interest rate calculation) Defne agrees to lend Ozan 800 T

Question

Problem 1 (related to interest rate calculation) Defne agrees to lend Ozan 800 TL. They agree to a nominal interest rate of 9%. Both expect the inflation rate to be 4%. (a) Calculate the expected real interest rate. (b) If inflation turns out to be 5% over the life of the loan, what is the real interest rate? Who gains from unexpectedly high inflation, Defne or Ozan? Why? (c) If inflation turns out to be 2% over the life of the loan, what is the real interest rate? Who gains from unexpectedly high inflation, Defne or Ozan? Why?

Explanation / Answer

a) Expected real interest rate = Nominal interest rate - expected inflation = 9% - 4% = 5%

b) Real interest rate is 4% because it is the difference between nominal interest rate and inflation rate. Since real interest rate is reduced the lender receives a lower amount in return so Define is hurt when inflation is higher than expected

c)  Real interest rate is 7% because it is the difference between nominal interest rate and inflation rate. Since real interest rate is increased the lender receives a higher amount in return so Define is a winner and Ozan hurts when inflation is lower than expected

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.