EXERCISE 3 Inflation (30 points) PART ONE (12 points) Steve wants to borrow $2,0

Question

EXERCISE 3 Inflation (30 points) PART ONE (12 points) Steve wants to borrow $2,000 from Harry and promises to repay the borrowed money plus interest a year from now. During the course of the year Harry anticipates that inflation will be 14% while Steve anticipates that inflation will be 12%. Use this information to answer this series of questions: Steve is willing to pay a 7% for this loan. If Harry charges Steve a nominal interest rate of 5%, will Steve borrow the money? (6 points) Steve has agreed to pay Harry $2,500 at the end of the year. If Harry loans Steve $2,000 at the beginning of the year. If inflation is 15% for the year, what is the real interest rate that Steve will pay for this loan? (6 points) a) b)

Explanation / Answer

A. Yes steve has to borrow the money not that about the nominal interest rate but for the loan

B. The real rate of interest that would be paid by the sterve is 15%.

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