Frank is lending $1000 to Sara for two years. Frank and Sara agree that Frank should...

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Frank is lending $1000 to Sara for two years. Frank and Sara agree that Frank should earn a 2% real return per year. The CPI

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Answer 1

Answer #1

Given real interest rate Frank should earn = 2%

We know Real Rate = Nominal Interest - Inflation

Therefore, to calculate the nominal interest rate, we must calculate the inflation.
In the question it is given CPI in year 0 is 1, CPI in year 1 is 1.1 & CPI in year 2 is 1.21. Using CPI, calculate the inflation.

Inflation = (CPI of Current Yr - CPI of Previous Yr)/CPI of previous yr *100

Inflation year 1 = (1.10-1)/1*100=10%

Inflation year 2 = (1.21-1.10)/1.10*100=10%

Nominal interest rate = Real Interest + Inflation

The nominal interest rate to get real interest rate should be 2%+10%=12%

The nominal rate of interest Frank charges Sarah in year one is 12%.

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Answer 2

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