If you expect the inflation premium to be 2%, the default risk premium to be 1% and the real interest rate to be 4%, what interest would you expect to observe in the marketplace under the simplest form of market interest rates?
A)4%
B)7%
C)2%
D)1%

Question

Quizplus · Accepted Answer

The simplest form of market interest rates is the nominal interest rate which is equal to the real interest rate plus the inflation premium and the default risk premium.

Nominal interest rate = real interest rate + inflation premium + default risk premium

= 4% + 2% + 1%

= 7%

Therefore, the expected interest rate in the marketplace would be 7%. Hence, option B is the correct answer.

If You Expect the Inflation Premium to Be 2%, the Default