Interest 05

Question 1

1. What is the NOMINAL INTEREST RATE?

Answer 1

It is the amount, in PERCENTAGE terms, of interest payable.

Question 2

2. You deposit $100 in your bank for one year and at the end of the year receive $10 interest. What is the NOMINAL INTEREST RATE?

Answer 2

At year end the balance is $110, so the NOMINAL INTEREST RATE is 10% per annum.

Question 3

3. What is the REAL INTEREST RATE?

Answer 3

It is calculated by adjusting the NOMINAL RATE to take inflation into account. If inflation has been 10% in the year, then the $110 at the end of the year buys the same amount as $100 did a year ago. THE REAL INTEREST RATE IN THIS CASE IS ZERO.