Assume you just deposited ksh 100,000 into a bank account. The current real interest rate is 2%, and inflation is expected to be 6% over the next year. What nominal rate would you require from the bank over the next year? How much money will you have at the end of one year? If you are saving to buy a stereo that currently sells for sh.100,000, will you have enough money?
To find the nominal rate required from the bank, we need to adjust for inflation. The nominal interest rate is the real interest rate plus the inflation rate.
In this case, the real interest rate is 2% and the expected inflation rate is 6%. So the nominal rate required from the bank would be:
Nominal Rate = Real Interest Rate + Inflation Rate
Nominal Rate = 2% + 6%
Nominal Rate = 8%
Therefore, you would require an 8% nominal interest rate from the bank over the next year.
To calculate how much money you will have at the end of one year, we need to apply the interest rate to the initial deposit.
Final Amount = Initial Deposit + (Initial Deposit x Nominal Rate)
Final Amount = 100,000 + (100,000 x 8%)
Final Amount = 100,000 + 8,000
Final Amount = 108,000
At the end of one year, you will have 108,000 Ksh.
Now, let's see if you will have enough money to buy the stereo that currently costs 100,000 Ksh. Since you will have 108,000 Ksh, you will indeed have enough money to buy the stereo.
Please note that this calculation assumes you do not make any additional deposits or withdrawals during the year, and it does not account for any taxes or fees that may be applicable.