Question

Suppose you borrow $1,000 of principal that must be repaid at the end of two years, along with interest of 5 percent per year. If the annual inflation rate turns out to be 10 percent,

Instructions: Enter your responses rounded to the nearest whole number. If you are entering any negative numbers be sure to include a negative sign (-) in front of those numbers.
a. What is the real rate of interest on the loan?
b. What is the real value of the principal repayment?
Hint: Future value = Present value × (1 + Growth in prices)t, where t is the number of years evaluated, e.g., The real value of loan repayment = Amount of loan × (1 + Real interest rate)t
c. Who loses, the debtor or the creditor?

Answer 1

Following are the solution to the given question:

Step-by-step explanation:

For point a:

Calculating the Real rate of interest:

`\to 5\%-10\%\\\\\to -5\%`

For point b:

Calculating the Real value of loan repayment:

`\to \$1000 (1-0.05)^2\\\\\to \$902.5`

For point C:

In this question, the creditor receives less than what he granted he losses that's why the creditor is the correct answer.