Question

Paul lends R10 000 to his friend Steven for one year. They agree that Steven would pay the R10 000 back with 5% interest at the end of the year. If the inflation rate is 6% at the end of the year, which of the following would be true for the real value of the amount that Steven pays back ?

Answer 1

Loan amount = R 10,000

Nominal rate = 5%

Inflation rate = 6%

Therefore

      $Real rate = [\frac{(1+Nominal \space rate)}{(1+Inflation\space rate)}]-1\\ = [\frac{(1+0.05)}{(1+0.06)}]-1\\ = \frac{1.05}{1.06}-1\\ = 0.990566037735849-1\\ = -0.00943396226415105$

As per formula

            Real value after 1 year = Loan amount$\times$ (1+Real rate)

                                                   $= 10000\times(1-0.00943396226415105)\\ = 10000\times 0.990566037735849\\ = 9905.66$

Real value of the amount that Steven pays back = R 9905.66