Loretta agrees to lend Ted $500,000 to buy computers for his consulting firm. They agree to a nominal interest rate of 8%. Both expect the inflation rate to be 2%.

a. Calculate the expected real interest rate.

b. If inflation turns out to be 3% over the life of the loan, what is the real interest rate? Who gains from unexpectedly high inflation, Loretta or Ted?

c. If inflation turns out to be 1% over the life of the loan, what is the real interest rate? Who gains from unexpectedly low inflation, Loretta or Ted?