econ 4.2 - nominal v. real interest rates
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nominal interest rates
percentage increase in money that the borrower pays (not adjusted for inflation)
real interest rates
percentage increase in purchasing power that a borrower pays (adjusted for inflation).
formula for present value
$X in 1 Year = ------ $X / (1 + ir)^N
formula for future value
$X in N Years = $X (1 + ir)^N ------ ir = interest rate
formula for nominal interest rates
nominal = real interest rate + expected inflation
formula for real interest rate
real = nominal interest rate - expected inflation