Suppose you borrow $1,000 of principal that must be repaid at the end of two years, along with interest of 5 percent per year. If the annual inflation rate turns out to be 10 percent,
a. What is the real rate of interest on the loan?
b. What is the real value of the principal repayment?
Hint: Future value = Present value × (1 + Growth in prices)^t, where t is the number of years evaluated, e.g., The real value of loan repayment = Amount of loan × (1 + Real interest rate)^t
c. Who loses, the debtor or the creditor?