You may have heard of many types of interest rates, such as floating interest rates, fixed interest rates… but did you know? What is nominal interest rate and real interest rate? not yet? In this article, banktop.vn will help you learn the difference between nominal and real interest rates and how it is calculated.
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Table of Contents
Understand the concept of real interest rate and nominal interest rate
What is the nominal interest rate?
Nominal interest rate is understood as the interest rate of a loan or investment on paper, not the real one because inflation and the influence of compound interest are not taken into account – According to wikipedia.
EgWhen you installment loan At the bank, the interest rate applied to your loan is 10%/year, that means the nominal interest rate on your loan is 10%.
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However, there is a fact that always happens to the economy that is inflationary, and inflation will directly affect interest rates. The final interest rate minus the nominal interest rate minus the inflation rate is called the real interest rate.
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- What is a floating interest rate?
What is real interest rate?
The effective interest rate is the real interest you can earn on an investment or pay on a loan after accounting for the impact of compound interest. The real interest rate is also the interest rate that investors hope to get after deducting the impact of the inflation factor.
See more: What is prime interest rate?
What is the difference between real interest rate and nominal interest rate?
Different in nature
The real interest rate is the interest rate calculated after deducting the inflation rate. In contrast, the nominal interest rate will not take into account inflationary factors.
Differences in characteristics
The nominal interest rate is more of a reference when compared to the real interest rate. Real interest rates are applied to measure the purchasing power of interest receipts.
Differences in calculation
- The calculation of the nominal interest rate is not difficult. That is the interest rate offered by the bank on paper. Suppose, when you take out an unsecured loan with an interest rate of 15% per year, the nominal interest rate is also this 15%.
- In contrast, the real interest rate remains after the nominal interest rate minus the inflation rate. The real interest rate is calculated by the formula: (1 + r)(1 + i) = (1 + R) where: r is the real interest rate, i is the inflation rate and R is the nominal interest rate.
See also: what is compound interest?
Formula to calculate Nominal Interest and Real Interest
The formula for calculating nominal interest rate
It can be understood that the nominal interest rate is the interest rate that the credit unit gives you in the transaction. For example, if you borrow $100,000 from a bank with an interest rate of 5%, the nominal interest rate is 5%.
Formula to calculate real interest rate
The real interest rate is approximately equal to the nominal interest rate minus the inflation rate. This is the interest rate investors hope to receive after deducting inflation.
These are not mere numbers, as different investors have different inflation rate expectations. If an investor receives a 5% return next year and predicts that inflation is 2%, he expects a real return of 3%.
However, if the inflation rate is 2%, then the real interest rate is 3% (5-2). Basically, the real interest rate is calculated by subtracting the inflation rate from the nominal interest rate.
Formula to calculate real interest rate is calculated as follows:
- i = nominal interest rate
- r = real interest rate
- E(I) = expected inflation rate
The formula for calculating the inflation rate is calculated as follows:
See more: The fastest and most accurate way to calculate the bank loan interest rate
Relationship between Real Interest Rate and Nominal Interest Rate
The relationship between the real interest rate and the nominal interest rate is expressed by the following formulas:
(1 + r)(1 + i) = (1 + R)
- r is the real interest rate,
- i is the inflation rate
- R is the nominal interest rate.
Real interest rate = Nominal interest rate – Expected inflation rate
Real interest rates and nominal interest rates always have a certain degree of contrast when it comes to inflation. The real interest rate will be inversely proportional to the inflation rate. But when it comes to reality, the inflation rate when it occurs may be different from the expected inflation rate. Therefore, you cannot know in advance exactly what the actual interest rate will be.
On the contrary, the nominal interest rate will be announced shortly afterwards to the borrower, the investor.
See more: What is the interbank rate?
Thus we can see that, between the real interest rate and the nominal interest rate, the most basic difference is that it is subject to and not affected by inflation. Banktop.vn advises you, when saving or borrowing money quickly, choose the most appropriate time to effectively minimize the impact of inflation.
Information edited by: banktop.vn