Suppose that a bank wishes to make a 5% rate of return on a one-year loan but expects inflation over the course of the loan to be roughly 3%. Which statement is TRUE?
A) As long as the bank charges a nominal interest rate of at least 5%, it will earn its expected return.
B) If the bank charges an interest rate of 8% or higher, it will earn the expected return.
C) If the bank charges 8% and the inflation rate is less than 3%, then the bank will have earned a higher rate of return than expected.
D) If the bank charges 8% and the inflation rate is more than 3%, then the bank will have earned a higher rate of return than expected.

Question

Quizplus · Accepted Answer

The bank needs to charge a nominal interest rate that accounts for both the desired real return and expected inflation. If the bank charges 8% and inflation is less than 3%, the real return will be higher than the expected 5%.

Suppose That a Bank Wishes to Make a 5% Rate