4.2 Nominal vs Real Interest Rates

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4 Terms

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Nominal Interest Rates

  • rates presented by banks when you buy a new car, house, or any loan

  • NOT adjusted for inflation!

Nominal Rate = Real Rate + Inflation Rate

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Real Interest Rates

  • Real rate of return earned on financial assets (ex. bonds) or paid back on loans

  • inflation is REMOVED

Real Rate = Nom. Rate - Inflation Rate

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Anticipated vs Unanticipated Inflation

  • Lenders, borrowers, and savers make decisions based on expected inflation

  • unexpected inflation - lenders lose $

Charge extra % on top of expected inflation to earn $
ex. exp. inf. 2% + real int. goal of 6% = charge 8%

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Bond Formula

Yield (return rate) = (Annual Interest Payment)/(Bond Price)

OR

Bond Price = Interest Payment)/(Yield Rate Decimal)