Question

10. Consider the situations of a lender of money and a borrower of money. Which of the following situations is least burdensome for the borrower? a. nominal interest rate of 15% and an inflation rate of 8% b. nominal interest rate of 10% and an inflation rate of 1% c. nominal interest rate of 8% and an inflation rate of 2% d. nominal interest rate of 4% and an inflation rate of 4% e. nominal interest rate of 29% and an inflation rate of 21%

Answer 1

SOLUTION :

Borrower pays interest on the money borrowed to the lender. From the point of view of the borrower, lower the inflation adjusted interest rate (real rate) better it is. In that case borrower’s financial cost is lower.

Accordingly , the lowest real rate should be the choice of the borrower .

In this case :

Nominal rate            Inflation rate          Real rate (Nominal- Inflation)

      15%                           8%                              7%

 

      10%                           1%                              9%

       8%                            2%                              6%

       4%                            4%                              0%

      29%                          21%                             8%

So,

 

Nominal rate of 4% and inflation rate of 4% result into the real rate of 0%which is the lowest of all situations and so, this situation is the least burdensome for the borrower. (ANSWER).         

Answer 2

Ans is D

Borrower is least burden some when the real interest rate is lowest

and real interest rate=Nominal interest rate-inflation rate

option D has real interest rate=0 because Nominal interest rate=inflation rate