Suppose a loan of $100 is made at a fixed nominal interest rate of 5% for one year. During the year,there is unexpected inflation of 7%. Which of the following is true?

Question

Quizplus · Accepted Answer

The unexpected inflation of 7% means that the borrower's money is worth less at the time of repayment. Therefore, the inflation has benefited the borrower and redistributed income from the lender to the borrower. The real rate of interest is 2% (5% nominal interest rate minus 7% inflation rate). The borrower will be obligated to repay $105 ($100 principal plus 5% nominal interest), not $107.

Suppose a Loan of $100 Is Made at a Fixed