In: Finance
If a loan is discounted, relative to the stated rate of interest the real rate of interest is?
A. higher
B. lower
C. the same
Option B is correct: Lower
If a loan is discounted, relative to the stated rate of interest the real rate of interest is lower.
This is because of inflation. The expected rate of inflation is subtracted from the stated rate of interest to arrive at the real rate of interest. So, the real rate of interest will be lower than the stated rate of interest.
Example: Stated rate of interest = 4%
The expected inflation rate = 1.5%
The real rate of interest = Stated rate of interest - The expected inflation rate
The real rate of interest = 4% - 1.5%
The real rate of interest = 2.5%
This is lower than 4%