Distinguish between the nominal rate and the real rate of interest. How does inflation affect the...

Distinguish between the nominal rate and the real rate of interest. How does inflation affect the real, ex post (after the fact) rate of return to investors?

Expert Solution

Nominal Rate is the Rate of Interest that will be received on Investing Money.

But, there is also Inflation, due to which Value of Money REDUCED in future. Real Rate of Interest is the rate earned on the Invested Money, AFTER ADJUSTING INFLATION.

For Example, $100 is Invested @10% and Inflation is 5%. In this case, If $100 is invested, after 1 year, $110 will be received. Therefore, Nominal Rate is 10%. But, due to 5% Inflation, REAL VALUE of that $110 is 110/1.05 = 104.76. Therefor, Real Rate is 4.76%

Therefore, If Inflation is Positive, it will REDUCE THE RETURN TO INVESTORS.

jeff jeffy answered 2 years ago

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