Inflation and Interest Rates

Inflation and Interest Rates - invested because of...

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Chapter 7.6: Inflation and Interest Rates Real rates – rates that have been adjusted for inflation o Percentage change in how much you can BUY with your dollars (percentage change in your BUYING POWER) Nominal Rates – rates that have NOT been adjusted for inflation o Percentage change in the NUMBER of dollars you HAVE Fisher effect – relationship between real returns, nominal returns, and inflation o Tells us the nominal rate has three components: The real rate on investment The compensation for the decrease in the value of the money originally
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Unformatted text preview: invested because of inflation Compensation for the fact that the dollars earned on the investment are also worth less because of the inflation (usually small so often dropped) Financial rates are almost always quoted in nominal terms Effect of inflation on present value calculations: Either discount nominal cash flows at a nominal rate or discount real cash flows at a real rate (doesn’t matter as long as you are CONSISTENT)...
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