Class 12 &quot;and 15&quot; Completed

This preview shows pages 5–12. Sign up to view the full content.

How many cookies can you buy with \$110? K New cookie price is \$1.05 K So with \$110, you can buy \$110/\$1.05 = 104.76 cookies. – You are 4.76 cookies better off (=4.76%) compared to last year. – Your purchasing power went up by 4.76%. 5

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
6 The Fisher Effect K Relationship between nominal interest rates, real interest rates, and the rate of inflation ( π ). K This can be re-written as: K Which can be approximated for low inflation rates as: 1 + r real = 1 + r nom 1 + ! = Growth in Money Growth in Prices r real = 1 + r nom 1 + ! ! 1 = 1 + r nom 1 + ! ! 1 + ! 1 + ! = 1 + r nom ! (1 + ! ) 1 + ! = r nom ! ! 1 + ! r real ! r nom " ! or r nom ! r real + !
7 The Fisher Effect and Oatmeal Raisin Cookies K For our example above, this means: r nom = 10% π = 5% The approximation results in a real rate of 5% % 76 . 4 05 . 1 05 . 0 1 . 0 1 = = + = π π nom real r r

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
8 iClicker Example: Real World Real Rates Example K In 2000, short-term Canadian bond rates were about 5.8% and the inflation rate was about 3%. K In 2003, interest rates were about 2.7% and the rate of inflation was 3.1%. K What were the real returns for 2000 and 2003, respectively? a) 2.8%; -0.4% b) 2.8%, 0.4% c) 2.7%, - 0.39% d) 2.7%, 0.39% e) None of the above.
9 iClicker Example: Real World Real Rates Example K In 2000, short-term Canadian bond rates were about 5.8% and the inflation rate was about 3%. K In 2003, interest rates were about 2.7% and the rate of inflation was 3.1%. K What were the real returns for 2000 and 2003, respectively? Correct solution is c: K For 2000: K For 2003: % 7184 . 2 1 03 . 1 058 . 1 = = real r % 3880 . 0 1 031 . 1 027 . 1 = = real r

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
10 Real and Nominal Interest Rates: Ex-Ante and Ex-Post K When a lending or borrowing decisions is made, the nominal interest rate is typically known. The rate of inflation over the investment horizon is unknown, and therefore the real rate of return is unknown as well. Therefore ex-ante, nominal interest rates are the sum of an expected real interest rate plus the expected rate of inflation. In any given year, the expected rate of inflation is unlikely to be equal to the actual (ex-post) rate of inflation. K So in any given year, the actual (ex-post) real rate of return will be different from the ex-ante expected real rate of return. Which is OK as long as on average, there is no bias towards either over- or underestimating inflation so that over longer time horizons, ex- ante and ex-post real returns are the same.
Mommy, Mommy, Where Do Interest Rates Come From?

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern