1. Real and Nominal Interest Rates

a. Explain the difference between a nominal versus a real interest rate.

b.If a bond gives you a 0.28% nominal annual interest rate and the inflation rate over the year is 0.62%, what is the real ex post rate of return you receive?

Real Rate You Receive _____________

Or including compounding effects:[1.0028 / (1.0062)] - 1 = -0.0034 or -0.34%

c.If an investor wants a real rate of return of 1% and expects inflation to be 0.62% next year, what nominal rate should the investor demand?

Nominal Rate Investor Demands __________

2. Loanable Funds Theory

a.Explain the loanable funds theory (fine to show graphs along with your explanation if you'd like).Be sure to explain the shape of the demand & supply curves for LFs, the net demanders and suppliers of funds, and the factors that affect the respective demand and supply for loanable funds.

b.If the Federal Reserve decided to reduce the money supply by engaging in open market bond sales to the non-bank public, explain what will happen to the equilibrium interest rate in the U.S. based on the Loanable Funds Theory (In your discussion mention or show with a graph any change in the demand or supply curves for loanable funds and the effect on the real equilibrium interest rate).

c.Using the loanable funds theory, explain what will happen to the real equilibrium interest rates if investors/savers become more risk adverse (in your discussion mention or show with a graph the change in the demand or supply curves for loanable funds and the effect on the real equilibrium interest rate).

d.Using the loanable funds theory and the demand and supply of loanable funds, explain what will happen to the real interest rate if a new technology is developed, and the demand for loans by businesses to finance projects to utilize this technology increases (in your discussion mention or show with a graph the change in the demand or supply curve for loanable funds and the effect on the real equilibrium interest rate).