Question

A lender who makes a $20,000 loan for one year and earns interest in the amount of $1,200, earns what nominal interest rate and what real interest rate if the inflation is four percent?

Group of answer choices
a. A nominal rate of 6% and a real rate of 10%.
b. A nominal rate of 6% and a real rate of 2%
c. A nominal rate of 5% and a real rate of 1%.
d. A nominal rate of 7% and a real rate of 12%.

Answer 1

The lender earns a nominal interest rate of 6% and a real interest rate of 2%, calculated by subtracting the 4% inflation rate from the nominal rate.

Step-by-step explanation:

The correct answer to the question is that the lender earns a nominal interest rate of 6% and a real interest rate of 2%. To calculate the nominal interest rate, we use the interest earned divided by the principal amount of the loan. In this case, $1,200 (interest earned) ÷ $20,000 (principal) equals a 6% nominal interest rate.

Now, to find the real interest rate, we need to account for inflation. The real interest rate is calculated by subtracting the rate of inflation from the nominal interest rate. Given an inflation rate of 4%, the real interest rate is therefore 6% (nominal rate) - 4% (inflation rate), which is 2%.

This demonstrates how inflation can erode the power of interest earnings and how the nominal interest rate can be distorted when considering the actual increase in purchasing power.