Marquis borrowed $1,000 from Ayana for a year and agreed to repay her $1,050 at the end of the year. If the inflation rate was 3 percent, what is the real rate of interest Ayana received?
A) 10 percent
B) 5 percent
C) 3 percent
D) 2 percent
E) −2 percent

Question

Quizplus · Accepted Answer

The nominal rate of interest that Ayana charged Marquis is 5 percent ($1,050 - $1,000 = $50, and $50/$1,000 = 0.05, or 5 percent). To find the real rate of interest, we need to adjust for inflation. If inflation was 3 percent, then the $1,050 that Ayana received at the end of the year would only be worth $1,019.42 in today's dollars ($1,050 / 1.03 = $1,019.42). Therefore, the real rate of interest that Ayana received is $19.42/$1,000 = 0.01942, or 1.942 percent. This is approximately 2 percent, so the answer is D.

Marquis Borrowed $1,000 from Ayana for a Year and Agreed