Question

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

A) -12 percent.
B)..2 percent.
C) 2 percent
D) 12 percent.

Answer 1

The real interest rate of a bond is found by subtracting the inflation rate from the nominal interest rate. With a 7% nominal yield and a 5% expected inflation rate, the real interest rate on the bond would be 2%.

Step-by-step explanation:

If you expect the inflation rate to be 5 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond can be calculated as follows:

The real interest rate is basically the nominal interest rate minus the inflation rate. Using the given figures, the real interest rate would be 7 percent (nominal interest rate) minus 5 percent (inflation rate), which equals a 2 percent real interest rate.

Therefore, the correct answer is C) 2 percent.