Final answer:
Investors seeking a 5% real interest rate with a 1.5% inflation rate need to earn a nominal interest rate of 6.5%, with the closest answer being 6.6% (option d). It's important to consider both inflation and taxes when looking at interest rates.
Step-by-step explanation:
If investors wish to earn a real interest rate of 5 percent, with an inflation rate of 1.5 percent, the nominal interest rate they must earn can be calculated by the Fisher equation, which is expressed as:
Nominal Interest Rate = Real Interest Rate + Inflation Rate
Therefore, Nominal Interest Rate = 5% + 1.5% = 6.5%. The closest answer from the options given is d) 6.6%.
The Fisher equation highlights the relationship between real, nominal, and inflation rates. It's crucial for investors to consider these rates, especially when the inflation rate is significant. Without adjusting for inflation, an investor may end up with a loss of purchasing power even if the nominal rate seems attractive. Moreover, the effect of taxes on the nominal interest can diminish the real rate even further, leading to a scenario where a positive nominal rate translates into a stagnation or decline in the real value of the investment.