1. For the following statement, state Agree or Disagree. And provide brief expla
ID: 1134856 • Letter: 1
Question
1. For the following statement, state Agree or Disagree. And provide brief explanation.
c) Suppose that Jim buys bonds from a firm and both the firm and Jim expect a 2 per cent inflation rate for the year. Given this expectation, suppose that the nominal interest rate on the bonds is 6 per cent after Jim buys the bonds the inflation rate turns out to be 6 per cent, rather than the 2 per cent that had been expected. The firm gains from this unexpectedly high inflation rate and Jim loses out. (1 mark)
Explanation / Answer
AGREE.
Explaination:
The interest rate is the price of the loanable funds in the economy. The nominal interest rate is the interest rate that is not adjusted for inflation. The real interest rate is nominal interest rate minus inflation. The interest rate is the earning on loanable funds supplied by the lender. The inflation decreases the future value of the currency. At the time of rising inflation the lender tend to lose out as they receive less value from their investment than they would have without rising inflation.
In this case the value of $100 after adjested for inflation is still $100 after the one year period. As rise in value of money by 6% nominal interest rate is taken out by rising inflation of 6%. Then the investor, that is the person buying the bond loses from his inveatment and the firm gains from the same.
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