Suppose that you borrow $5,000 from the bank to purchase some land and you agree to pay 9 percent interest on the loan. If the loan must be repaid in 12 months and the inflation rate is 13 percent during the year, then
A)you will repay the bank with dollars with more purchasing power than you initially borrowed.
B)you will repay the bank with fewer dollars than the bank initially loaned you.
C)you will repay the bank with dollars with less purchasing power than it initially loaned you.
D)the bank will receive fewer dollars, because of inflation, than it had initially expected to receive.

Question

Quizplus · Accepted Answer

Due to the inflation rate of 13 percent, the purchasing power of the dollars decreases over the 12 months, which means that the dollars that you pay back have less purchasing power than the dollars you borrowed initially. Therefore, you will repay the bank with dollars that have less purchasing power than it initially loaned you.

Suppose That You Borrow $5,000 from the Bank to Purchase