Question

Statistics

Posted 5 months ago

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The Iron Bank wants to make sure that the purchasing power of the interest that they get paid on loans is at least $11 \%$. Real GDP is increasing at $5 \%$ per year, and the expected rate of inflation is $7 \%$ per year.
If all banks in Westeros want to earn the same real return as the Iron Bank, what is the nominal interest rate (n.i.r)?
Choose 1 answer:
(A) $2 \%$
(B) $16 \%$
(c) $6 \%$
(D) $18 \%$
(E) $11 \%$
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Answer from Sia

Posted 5 months ago

Solution by Steps

step 1

To calculate the nominal interest rate (n.i.r) that banks in Westeros should set to achieve the same real return as the Iron Bank, we use the Fisher equation, which relates the real interest rate (r), the nominal interest rate (i), and the inflation rate (π): $i = r + π$

step 2

The real return the Iron Bank aims for is 11%. This is the real interest rate (r): $r = 11\%$

step 3

The expected inflation rate (π) is given as 7%

step 4

Using the Fisher equation from step 1, we substitute the values of r and π to find the nominal interest rate (i): $i = 11\% + 7\%$

step 5

Calculating the sum of the real interest rate and the inflation rate gives us the nominal interest rate: $i = 18\%$

Answer

D

Key Concept

Fisher Equation

Explanation

The Fisher Equation relates the real interest rate, nominal interest rate, and inflation rate, and is used to determine the nominal interest rate needed to achieve a desired real return in the presence of inflation.

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