Define and describe nominal and real interest rates. What impact do interest rates have on the...

Define and describe nominal and real interest rates. What impact do interest rates have on the cost of financing a purchase? What is the discount formula.

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Expert Solution

Nominal interest rate refers to the interest rate before taking inflation into account. Nominal can also refer to advertised or stated interest rate on loan, without taking into account any fees or compounding of interest.

Real interest rate is one that is adjusted to remove the effect of inflation, reflecting the real cost of funds to the borrower and the real yield to the lender or investor.

Changes in interest rates have impact on the cost of financing a purchase as a decrease in interest rates lowers the cost of borrowing, which encourages business to increase investment spending.

We can calculate discount rate using the formula 1(1+i)^n where i represent the interest rates and n equals the number of year until we receive the cash flow. Discount rate represents the compensation that the investors require to assume the risk of investing in that asset in hope of receiving the future cash flows generate from it.

Rahul Sunny answered 1 year ago

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