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Explanation:
The approximate relationship between nominal rates, real rates and expected inflation rates can be written as:
Nominal risk-free rate = real risk-free rate + expected inflation rate.
Therefore we can rewrite this equation in terms of the real risk-free rate as:
Real risk-free rate = Nominal risk-free rate – expected inflation rate
The exact relation is: (1 + real)(1 + expected inflation) = (1 + nominal)
(Module 1.1, LOS 1.a)
The real risk-free rate can be thought of as:
A
approximately the nominal risk-free rate plus the expected inflation rate.
B
approximately the nominal risk-free rate reduced by the expected inflation rate.
C
exactly the nominal risk-free rate reduced by the expected inflation rate.
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