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15 June, 14:15

Treasury bills are currently paying 7 percent and the inflation rate is 3.2 percent. a. What is the approximate real rate of interest? (Enter your answer as a percent rounded to 2 decimal places, e. g., 32.16.) b. What is the exact real rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e. g., 32.16.)

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  1. 15 June, 14:31
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    The real risk free rate is 3.8%

    The exact risk-free rate is 3.68%

    Explanation:

    The interest rate on the Treasury bills is usually a combination of real risk free rate and inflation rate to compensate investors for average inflation in the economy during the instrument lifetime which equals nominal risk-free rate.

    nominal risk-free rate = real risk-free rate+inflation rate

    nominal risk-free rate=7%

    inflation rate=3.2%

    real risk-free rate=7%-3.2%

    real risk-free rate=3.8%

    The exact real risk-free rate can be computed thus:

    nominal rate+1 = (real risk-free rate+1) * (inflation rate+1)

    real risk-free rate = (nominal rate+1) / (inflation rate+1) - 1

    real risk free rate = (1.07/1.032) - 1

    real risk-free rate=0.036821705

    real risk-free rate=3.68%
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