Question

Explain the difference between nominal and real interest rates. Assume current interest rates and that you have a loan for a vehicle. You will have to look up current interest rates and the inflation rate. What is your nominal and your real interest rate? Calculate. Explain what might happen if the Federal Reserve increases interest rates by .25 points. What is the impact on your rate(s)?

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Answer 1

The real and nominal interst rate difference lies on the consideration of inflation. When we consider the concept of interest rate mainly add with the long term investments and that fixed income is known as simply interest. The interest can have different forms like annual interst rate and nominal interst rate ,compound or effective interest rate real interest rate etc.
Here nominal or simple interst rate is the rate which is actual or nominal or par rate of interest in the long term or fixed income bearing securities like bonds ,debentures etc... And also it lies on loans. The nominal rate or coupon rate is explained with an exaple like ...if a bond have 6% nominal interest rate in the invest amount 100 then the fixed income generate periodically amount of six.but here a major problem lies in the nominal interest rate is not considering the inflation.and not taken the time value concept.here not the effect of compounding.
But in the real interest rate is the rate by which consider the inflation into accounts. And which is the inflation adjusted or deducted from the nominal rate of interest. So the investors or lenders get the real interest after adjust with the inflation factor.
When the economy the inflated time or boom situation then federal reserve try to increase their interest rate which consider the inflation factor.
In this vehicle loan situation the real interst rate will increase and that affect the higher cost to the person who takes the loans.