Nominal Rate of interest

Frank is lending $1,000 to Sarah for two years. Frank and Sarah agree that Frank should earn a real return of 2 percent per year.

Instruction: Enter your responses as integer values.

a. The CPI (times 100) is 100 at the time that Frank makes the loan. It is expected to be 108 in one year and 117 in two years. What nominal rate of interest should Frank charge Sarah? The nominal rate of interest charged should be %.

b. Suppose Frank and Sarah are unsure about what the CPI will be in two years. How should Frank index Sarah’s annual repayments to ensure that he gets an annual 2 percent rate of return?

Frank should charge Sarah % (Click to select) equal to more than less than the inflation rate.

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