Question

Pablo recently lent $5,000 to his friend Kristine to open a bakery. She promised to pay him back with interest within one year. Pablo and Kristine agreed on a nominal interest rate of 5.5 percent. If the annual rate of inflation is 0.5 percent, what kind of profit can Pablo expect to receive for his investment?

How much interest will Pablo receive from his investment?

$200 due to a real interest rate of 4 percent
$250 due to a real interest rate of 5 percent
$300 due to a real interest rate of 6 percent
$350 due to a real interest rate of 7 percent

Answer 1

Real interest ≈ nominal − inflation = 5.5% − 0.5% = 5.0%.

Interest in dollars (real purchasing‑power gain) = $5,000 × 5% = $250.

(You would receive $275 nominal interest, but after 0.5% inflation the real gain is $250.)

Answer: $250 due to a real interest rate of 5 percent.