What are Real and Nominal Interest Rates

Introduction   

In order to make prudent financial decisions, finance assignment help to understand the basic difference between the nominal and real interest rates is considered essential. The rate of inflation is interlinked with the nominal and real interest rates. This paper addresses the issues related to the nominal and real interest rates and their linkage with the rate of inflation. Further, the paper also puts light on the use of these interest rates in the financial decision making with a view to provide finance homework help online. In particular, the understanding of the real and nominal interest rates is essential in the capital budgeting decisions and evaluating the investment options.

Real Interest Rate   

As per the views of the essay writers, the rate of interest arrived at after adjusting for inflation effect is called the real interest rate. This implies that the rate of interest after deducting the rate of inflation is called real interest rate. The real rate of interest is normally lower than the nominal interest rate as asserted by the experts providing help with finance assignment. However, it may also be higher than the nominal interest rate in cases when the rate of inflation is negative. For example, consider the interest rate quoted by a bank 6% and the rate of inflation 3%, then the nominal interest rate will be 9% and the real interest rate will be 6% (9%-3%). However, if in this example, the inflation rate happens to be -2%, then the real interest rate will be 11% [(9%) - (-2%)]. Therefore, in the second example, it can be seen that due to negative inflation rate, the nominal interest rate happens to be lower than the real interest rate. In this regard, it is important to note that the rate of inflation can be negative and this phenomenon is called deflation, which is opposite of inflation.  

The discussion in the paragraph presented above makes it clear that the nominal interest rate is nothing but just the real interest rate adjusted for inflation. The nominal rate of inflation is adjusted for inflation in the manner prescribed below with the help of an example:

Nominal rate of interest = 10%

Inflation rate = 3%

(1+Real interest rate) = (1+0.07)*(1+0.03)

Real interest rate = 10.21%    

Other Points 

• Nominal rate of interest is what is quoted by the bank, but the real interest rate is the one which is effectively received by the depositor after considering inflation.   

• Higher the rate of inflation higher will be the required rate of return of the investor. The investor would like to invest only in the economies, which are fulfilling the investor’s expectations.

• Financial management assignment help reveals that the higher rate of inflation is considered to be unfavorable for the economy as it lowers the investment and thereby causes a recession in the economy. The recession affects the entire economy causing downfall in the business and employment.

 

• Consider an example, the investor receives 8% return, inflation is also 8%, then the effective return of the investor would be zero. This is because the receipts of the investor on investment had lost their value entirely due to inflation. Thus, in this case, the investor would require at least 16% return from the investment.         

The main theme of this paper is to help with accounting homework by way of a discussion on the nominal and real interest rates. The only difference between the real and the nominal interest rate is of the rate of inflation. The real interest rate is increased with the rate of inflation so as to arrive at the nominal rate of interest. The understanding of the nominal and real interest rates is of immense importance in the financial decision making. The investment decisions taken without considering the rate of inflation may result in heavy losses. This paper addresses all these aspects pertaining to the nominal and real interest rates and the inflation in a great detail.