Suppose that the nominal rate of interest is 4 percent and the inflation premium is 2 percent. What is the real interest rate? % Alternatively, assume that the real interest rate is 1 percent and the nominal interest rate is 6 percent. What is the inflation premium? %

(A) real rate of return 2$

(B) inflation premium 5%

Explanation:

The Inflation premium is an additional return over the rate of return. His goal is to compensate the loss of value in their capital due to inflation.

nominal rate = rate of return + inflation premium

(A)

nominal interest rate = 4%

inflation premium = 2%

nominal rate - inflation premium = real interest rate

4% - 2% = reail interest rate = 2%

(B)

nominal interest rate = 6%

real interest rate = 1%

nominal rate - inflation premium = real interest rate

6% - inflation premium = 1%

inflation premium = 6% - 1% = 5%