An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects inflation to be 2 percent next year. The nominal rate she must charge is about
A)3 percent.
B)2 percent.
C)1 percent.
D)5 percent.
E)7 percent.

Question

Quizplus · Accepted Answer

The nominal rate is equal to the real rate plus the expected inflation rate. In this case, the investor requires a 3 percent increase in purchasing power, so the real rate is 3 percent. She expects inflation to be 2 percent, so the nominal rate should be 5 percent (3% real rate + 2% expected inflation rate). Therefore, the answer is D.

An Investor Requires a 3 Percent Increase in Purchasing Power