econ 4.2 - nominal v. real interest rates

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