Laura wants to get 8% in real return of her certificate of deposit. If the annual inflation rate is estimated at 2%, how much should her nominal interest be?
Question
Laura wants to get 8% in real return of her certificate of deposit. If the annual inflation rate is estimated at 2%, how much should her nominal interest be?
Solution
To calculate the nominal interest rate, Laura needs to use the Fisher equation, which is:
1 + nominal rate = (1 + real interest rate) * (1 + inflation rate)
Laura wants a real return of 8% (or 0.08 in decimal form) and the inflation rate is estimated at 2% (or 0.02 in decimal form). Substituting these values into the Fisher equation gives:
1 + nominal rate = (1 + 0.08) * (1 + 0.02)
Solving this equation step by step:
- Calculate the value of (1 + 0.08) * (1 + 0.02) = 1.08 * 1.02 = 1.1016
- Subtract 1 from this result to find the nominal rate: 1.1016 - 1 = 0.1016
So, Laura's nominal interest rate should be approximately 10.16%.
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