Question

[25/10, 20:26] Atna Koh: Interest rates can be expressed in real or nominal terms. Which of the following is most correct?
[25/10, 20:26] Atna Koh: Select one:
a. Market rates are always expressed in real terms, because it is important that inflation be included in financial assessment.
b. Real interest rates can be accurately calculated as the difference between nominal rates and the inflation rate.
c. Because market rates are usually in nominal terms, cash flows will usually be in inflation-adjusted terms.
d. Market rates are only meaningful in nominal terms, because an accurate adjustment for inflation is not possible.

Answer 1

Sol: Lets first understand the concept of Nominal Interest Rate & Real Interest Rate.

Nominal Interest Rate => It is the percentage increase in money you pay the Bank/Financial Institution/lender for the use of the money you borrowed from them in form of Loan. If the nominal rate on a loan is 6%, borrowers need to pay $6 of interest for every $100 loaned to them. it is also known as coupon rate.

Real Interest Rate => It is named as Real Interest rate, as it considers & factor in the inflation rate in the equation.It is basically the Nominal Interest rate after adjusting Rate of Inflation.This is effective rate of interest you pay(recieve) on loan/funds borrowed.If an annually compounding bond lists a 8% nominal yield and the rate of inflation is 3%, then the real rate of interest is actually only 5%.
Formula for calculation =>
Real rate of return = Nominal Interest Rate - Real Interest Rate.

Option B - Real interest rates can be accurately calculated as the difference between nominal rates and the inflation rate.