Suppose you put $100 in the bank on January 1, 2017. If the annual nominal interest rate is 10 percent and the inflation rate is 5 percent, the real interest rate is ______ percent.

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BlackTom AI · Accepted Answer

We are evaluating the real interest rate when the nominal rate is 10% and the inflation rate is 5%.

First, consider the common approximation used in many introductory contexts: real interest rate ≈ nominal rate − inflation rate. In this case, 10% − 5% = 5%. This provides an intuitive sense of the real purchasing power gain from the nominal return after removing expected price increases.

Second, note that there is a more precise relationship between nominal rate, real rate, and inflation given by the Fisher equation: (1 + nominal) = (1 + real) × (1 + inflation). Solving for the real rate gives real ≈ (1 + 0.10)/(1 + 0.05) − 1 = 1.10/1.05 − 1 ≈ 0.0476, or about 4.76%. This is slightly lower than the simple difference due to the compounding effect.

In many problem settings, especially when not asked to apply the exact Fisher formulation, the approximate method (5%) is used and accepted as the real rate. Here, using the straightforward difference yields 5%, which aligns with the common teaching approach for quick estimates.

To summarize the key idea: subtracting inflation from the nominal rate gives a quick, intuitive estimate of the real rate (5%), while the exact Fisher calculation accounts for compounding and yields a slightly smaller value (approximately 4.76%).

FA25 ECON 302 002 Midterm Exam #3 (Chapters 7-9): Sample Questions

Suppose you put $100 in the bank on January 1, 2017. If the annual nominal interest rate is 10 percent and the inflation rate is 5 percent, the real interest rate is ______ percent.

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FA25 ECON 302 002 Midterm Exam #3 (Chapters 7-9): Sample Questions

Suppose you put $100 in the bank on January 1, 2017. If the annual nominal interest rate is 10 percent and the inflation rate is 5 percent, the real interest rate is ______ percent.

View Explanation

Log in for full answers

Similar Questions

If the nominal interest rate is equal to 5%, and the inflation rate is equal to -5%, then what is the real interest rate?

Part 1Suppose you postpone consumption and invest at​ 6% when inflation is​ 2%. What is the approximate real rate of your reward for​ saving? Part 1 A. ​4% B. ​3% C. ​5% D. ​6%

A year ago, you invested $10,000 in a savings account that pays an annual interest rate of 5%. What is your approximate annual real rate of return if the rate of inflation was 3.5% over the year?

You deposited your holiday bonus in your bank account on January 1, 2024. If the annual nominal interest rate is 4.3 percent and the inflation rate is 2.0 percent, you will earn ______ percent in real terms. Round your answer to the nearest tenth of a percent.

Finally, inflation rises to 6.5 percent and your bank adjusts the interest rate to 12.5 percent to maintain the same pre-tax interest rate (according to the Fisher equation). Calculate your real after-tax rate of return (in percent). Round your answer to the nearest tenth of a percent.

Suppose that you deposit money in your bank account on January 1, 2023. The annual nominal interest rate is 6.0 percent and the inflation rate is 3.3 percent. Your one-year real rate of return is ________ percent. Round your answer to the nearest tenth of a percent.

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If inflation is 3% and the market interest rate charged for a loan (the nominal interest rate) is 7.2%, what is the 'real' interest rate?

More Practical Tools for Students Powered by AI Study Helper

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Part 1Suppose you postpone consumption and invest at 6% when inflation is 2%. What is the approximate real rate of your reward for saving? Part 1 A. 4% B. 3% C. 5% D. 6%