Marks buys a one-year government bond on January 1, 2011, for $500. He receives

Question

Marks buys a one-year government bond on January 1, 2011, for $500. He receives principle plus interest totaling $515 on January 1, 2012. Suppose that the CPI is 200 on January 1, 2011, and 206 on January 1, 2012. This increase in prices is different than Hy had anticipated; his guess was that the CPI would be at 201 by the beginning of 2012. 4· Calculate the nominal interest rate and round your answer in percentage points to one decimal place. a. Nominal Interest Rate b. Calculate the actual inflation rate and round your answeriisto one decimal place Nominal Interest Rate Calculate the real interest rate and round your answer in percentage points to one decimal place. Nominal Interest Rate =

Explanation / Answer

Nominal interest rate is the interest rate without accounting for inflation.

Nominal interest rate= (515-500)/500
=15/500
=0.03
=3%

Actual inflation rate=(206-200)/200
=0.03
=3%

Real interest rate=Nominal interest rate-Actual inflation rate
=3-3
=0

Expected inflation rate=(201-200)/200
=1/200
=0.005
=0.5%

Expected real interest rate=nominal interest rate-expected inflation rate
=3-0.5
=2.5%

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