Under Which of the following conditions would you prefer to be the borrower ?
Correct answer: B. The nominal rate of interest is 20 percent and the inflation rate is 25 percent
- A. The nominal rate of interest is 12 percent and the inflation rate is 9 percent
- B. The nominal rate of interest is 20 percent and the inflation rate is 25 percent
- C. The nominal rate of interest is 5 percent and the inflation rate is 1 percent
- D. The nominal rate of interest is 15 percent and the inflation rate is 14 percent
Explanation
Borrowers benefit when inflation exceeds the nominal interest rate because the real interest rate becomes negative. In option b, the approximate real rate is 20% minus 25%, or negative 5%.
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