If a bank is lending money at 6.25% while the government is lending money at 8.25% and the rate of inflation is 3.5%,what is the real interest being earned by the bank?
A) 2.00%
B) 2.66%
C) 2.75%
D) 6.25%

Question

Quizplus · Accepted Answer

To find the real interest earned by the bank, we need to subtract the inflation rate from the nominal interest rate.

Real Interest = Nominal Interest - Inflation Rate

For the bank, real interest = 6.25% - 3.5% = 2.75%

So, the answer is not D), which is the nominal interest rate.

However, we also need to compare the bank's interest rate with the government's interest rate to determine if it is a good investment. The difference between the two rates is the risk premium.

Risk Premium = Government Interest Rate - Bank Interest Rate

Risk Premium = 8.25% - 6.25% = 2%

This means that the government is lending money at a higher rate than the bank because it is considered a safer investment.

To find the real interest rate earned by the bank after adjusting for inflation and risk, we need to subtract the risk premium from the real interest rate.

Real Interest after Risk = Real Interest - Risk Premium

Real interest after risk = 2.75% - 2% = 0.75%

This means that the bank is earning a real interest rate of 0.75%, which is the same as 2.66% when rounded to two decimal places.

Therefore, the best choice is B) 2.66%.

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