Thanks for the opportunity to answer your question!
In estimating correlations between nominal and real interest rates inflation, we may use the Fisher equation, often used in economics and financial mathematics. When we need to find the expected interest rate, we may use an augmented version of the Fisher equation.
Let’s let "r" stand for the real interest rate, "i" stand for the nominal interest rate, and "e" stand for the expected interest rate.
The Fisher equation thus reads:
1 + i = (1 + r) * (1 + e)
In substituting i with 13.75 and r with 7.05, we obtain the following equation:
1 + 13.75 = (1 + 7.05) * (1 + e)
14.75 = (8.05) * (1 + e)
14.75 / 8.05 = e + 1
2.092 = e + 1
2.092 - 1 = e
e = 1.092 rounded to two decimal places is 1.09
As we can see, 1.09% is your expected rate of inflation. Hope this helps!
Please let me know if you need any further clarification :)
Jul 2nd, 2015
Are you studying on the go? Check out our FREE app and post questions on the fly!