Suppose the nominal annual interest rate on a two-year loan is 8 percent and lenders expect inﬂation to be 5 percent in each of the two years. The annual real rate of interest is
A) 6 percent.
B) 8 percent.
C) 2 percent.
D) 3 percent.

Question

Quizplus · Accepted Answer

The real interest rate can be approximated using the formula: real interest rate ≈ nominal interest rate - inflation rate. Therefore, 8% - 5% = 3%.

Suppose the Nominal Annual Interest Rate on a Two-Year Loan