Inflation:: loans. HELP PLEASE.?

You are asked to lend a friend $100. The friend insists on paying you for the opportunity cost of using your money for a year. You agree that 3% is a reasonable return for the postponed use of your own money. It is predicted that the expected rate of inflation will be 8%. But you are concerned that inflation might be much higher, so to protect your purchasing power you ask your friend for payment of the $100 plus interest to date if the inflation rate goes above 8%. Interest to date would be the current inflation rate plus the 3% return.

If inflation stayed at 8%, what would your friend owe you? If the inflation rate increased to 10%, what would your friend owe you?

I know that Real Interest Rate = Nominal Interest Rate - Actual Inflation Rate. But I%26#039;m a bit confused on which is what. If someone can help with perhaps a way to set it up or something I%26#039;d appreciate it.

Thank you.

Inflation:: loans. HELP PLEASE.?

If inflation stays at 8% your friend owes you $100*1.11=$111.

If inflation jumps to 10% then they owe $100*1.13=$113.

The friend has insisted on paying a real interest rate of 3%. So to find the nominal interest rate you add 3% to the inflation rate. In the equations above 1 represents the principal while 0.11 and 0.13 represent the nominal interest rates which satisfy the 3% real interest rate requirement.