Loretta agrees to lend Ted $500,000 to buy computers for his consulting firm. Th

Question

Loretta agrees to lend Ted $500,000 to buy computers for his consulting firm. They agree to a nominal interest rate of 8%. Both expect the inflation rate to be 2%. (a) Calculate the expected real interest rate. (b) If inflation turns out to be 3% over the life of the loan, what is the real interest rate? Who gains from unexpectedly high inflation, Loretta or Ted? (c) If inflation turns out to be 1% over the life of the loan, what is the real interest rate? Who gains from unexpectedly low inflation, Loretta or Ted?

Explanation / Answer

Hi, Please find the answers as follows: a) 8 - 2 = 6% b) 8 - 3 = 5%, Ted gains from unexpectedly high inflation. c) 8 - 1 = 7%, Lorreta gains from unexpectedly low inflation. Thanks.

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