A firm takes a 2-year loan at a nominal interest rate of 8 percent.It believes that the inflation rate will be 4 percent this year and 2 percent next year.What annual average real interest rate does the firm expect to pay?
A) 2 percent
B) 3 percent
C) 4 percent
D) 5 percent

Question

Quizplus · Accepted Answer

The firm expects an average inflation rate of 3% over the two years (4% first year, 2% second year). The real interest rate is approximately the nominal rate minus the inflation rate: 8% - 3% = 5%.

A Firm Takes a 2-Year Loan at a Nominal Interest