The lender and borrower expect inflation rates of 5% in 2019,4.5% in 2020, and 3%...

The lender and borrower expect inflation rates of 5% in 2019, 4.5% in 2020, and 3% in 2021. What is the geometric average of the expected inflation rates? If the lender requires a real rate of interest of 5%, what nominal rate would (s)he set for a 3 year loan (assume the loan is structured such that principle and interest are due in one lump sum at loan maturity)?

Expert Solution

Geomatric Mean = (((1+r1) * (1+r2) * (1+r3)) ^(1/3)) - 1

= (((1+0.05) * (1+0.045) * (1+0.03)) ^(1/3)) - 1

= ((1.1301675)^(1/3)) - 1

= 1.04163189928 -1

= 4.16%

Nominal Return = ((1+Real Return) * (1+inflation Rate)) - 1

=((1+0.05) * (1+0.0416)) - 1

= 1.09368 - 1

= 9.37%

jeff jeffy answered 2 years ago

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