Suppose you borrow $1,000 of principal that must be repaid at the end of two years, along with interest of 5 percent a year. If the annual inflation rate turns out to be 10 percent,

(a) What is the real rate of interest on the loan?

For this I got -5%.

(b) What is the real value of the principal repayment?

?

(b) Round to nearest two decimal places.

1000 * .90 * .90 = ?

To calculate the real value of the principal repayment, we need to adjust it for inflation.

Given that the inflation rate is 10%, we can calculate the inflation-adjusted principal repayment as follows:

Principal repayment = Principal + (Principal * Inflation rate)
Principal repayment = $1,000 + ($1,000 * 0.10)
Principal repayment = $1,000 + $100
Principal repayment = $1,100

Therefore, the real value of the principal repayment is $1,100.

To find the real rate of interest, you need to take into consideration the inflation rate. The real rate of interest is the nominal interest rate minus the inflation rate.

Let's calculate the real rate of interest in this scenario:

(a) Real Rate of Interest:
Nominal interest rate = 5%
Inflation rate = 10%

Real rate of interest = Nominal interest rate - Inflation rate
Real rate of interest = 5% - 10%
Real rate of interest = -5%

So, the real rate of interest on the loan is -5%.

Now let's move on to part (b) to find the real value of the principal repayment.

(b) Real Value of Principal Repayment:
To calculate the real value of the principal repayment, we need to adjust it for inflation over the two years. The formula for the real value of money is:

Real Value = Nominal Value / (1 + Inflation Rate)^n

Where:
Nominal Value = $1,000 (principal repayment)
Inflation Rate = 10% (annual inflation rate)
n = 2 (number of years)

Real Value = $1,000 / (1 + 0.10)^2
Real Value = $1,000 / (1.10)^2
Real Value = $1,000 / 1.21
Real Value = $826.45 (rounded to two decimal places)

So, the real value of the principal repayment would be approximately $826.45.