Question

Suppose the tax rate on nominal interest income is 20% and does not change over time. Also assume the real interest rate remains constant. In year 1, the inflation rate is 4% and the nominal interest rate is 10%. In year 2, the inflation rate is 14% The real interest rate in both years is 16 The nominal interest rate in year 2 is 20 The after-tax nominal interest rate in year 1 is 7.

a. The after-tax nominal interest rate in year 2 is __________
b. The after-tax real interest rate in year 1 is ______________
c. The after-tax real interest rate in year 2 is ______________

Answer 1

a. The after-tax nominal interest rate in year 2 is __________

after tax nominal interest rate = 20% x (1 - tax rate ) = 20% x 0.8 = 16%

b. The after-tax real interest rate in year 1 is ______________

after tax real interest rate = [(1 + after tax nominal interest rate) / (1 + inflation rate)] - 1

after tax nominal interest rate yer 1 = 10% x 0.8 = 8%

inflation rate = 4%

after tax real interest rate = [1.08 / 1.04] - 1 = 3.85%

c. The after-tax real interest rate in year 2 is ______________

after tax real interest rate = [(1 + after tax nominal interest rate) / (1 + inflation rate)] - 1

after tax nominal interest rate yer 1 = 16%

inflation rate = 4%

after tax real interest rate = [1.16 / 1.14] - 1 = 1.75%

Step-by-step explanation:

year 1

inflation rate 4%

nominal interest rate 10%

real interest rate 6%

year 2

inflation rate 14%

nominal interest rate 20%

real interest rate 6%