Loquat Foods Company is able to borrow at an interest rate of 9 percent for one year. For the year, market participants expect 4 percent inflation.
a. What approximate real rate of return does the lender expect? What is the inflation premium embodied in the nominal interest rate?
b. If inflation proves to be 2 percent for the year, does the lender suffer? Does the borrower suffer? Why?
c. If inflation proves to be 6 percent, who gains and who loses?