Frank is lending $1,000 to Sarah for two years. Frank and Sarah agree that Frank should earn a 2 percent real return per year. Instructions: Enter your responses as whole numbers. a. The CPI (times 100) is 100 at the time that Frank makes the loan. It is expected to be 110 in one year and 121 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 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 real rate of return? Frank should charge Sarah % of the inflation rate.
Added by Courtney B.
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Given: CPI at the time of loan = 100 Expected CPI in 1 year = 110 Expected CPI in 2 years = 121 Inflation rate for year 1 = (110 - 100) / 100 = 0.10 or 10% Inflation rate for year 2 = (121 - 110) / 110 = 0.10 or 10% Show more…
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