Question

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is__________

Answer 1

1.9%

Step-by-step explanation:

Real interest is the return that investors would require without inflation.Money interest is the return that investors would require with inflation.The real interest can be calculated using the following formula:

(1+i)(1+r)=(1+)

where

i=inflation rate=5%

r= real interest rate

m= money interest rate =7%

(1+5%)(1+r)=(1+7%)

1+r=(1+7%)/(1+5%)

1+r=1.019

r=1.02-1=0.019

Real interest rate=0.019*100=1.9%