If the nominal interest rate is 6% and inflation is 2%, the real interest rate is:

If the nominal interest rate is 6% and inflation is 2%, the real interest rate is:

• A. 6%
• B. 2%
• C. 4%
• D. -2%

Answer: (C)

Real interest rate shows how much your purchasing power grows after removing inflation. The exact relationship is (1 + nominal) = (1 + real)(1 + inflation). With a nominal rate of 6% and inflation of 2%, (1 + real) = 1.06 / 1.02 ≈ 1.0392, so real ≈ 0.0392, or about 3.92%. Rounding to the nearest percent gives about 4%. Intuitively, a 6% nominal return minus 2% inflation leaves roughly 4% in real terms; the small difference from 4% is due to the compounding captured by the exact formula.

Real interest rate shows how much your purchasing power grows after removing inflation. The exact relationship is (1 + nominal) = (1 + real)(1 + inflation). With a nominal rate of 6% and inflation of 2%, (1 + real) = 1.06 / 1.02 ≈ 1.0392, so real ≈ 0.0392, or about 3.92%. Rounding to the nearest percent gives about 4%.

Intuitively, a 6% nominal return minus 2% inflation leaves roughly 4% in real terms; the small difference from 4% is due to the compounding captured by the exact formula.