Treasury bills are currently paying 7 percent and the inflation rate is 3.2 percent. a. What is the approximate real rate of interest? (Enter your answer as a percent rounded to 2 decimal places, e. g., 32.16.) b. What is the exact real rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e. g., 32.16.)

The real risk free rate is 3.8%

The exact risk-free rate is 3.68%

Explanation:

The interest rate on the Treasury bills is usually a combination of real risk free rate and inflation rate to compensate investors for average inflation in the economy during the instrument lifetime which equals nominal risk-free rate.

nominal risk-free rate = real risk-free rate+inflation rate

nominal risk-free rate=7%

inflation rate=3.2%

real risk-free rate=7%-3.2%

real risk-free rate=3.8%

The exact real risk-free rate can be computed thus:

nominal rate+1 = (real risk-free rate+1) * (inflation rate+1)

real risk-free rate = (nominal rate+1) / (inflation rate+1) - 1

real risk free rate = (1.07/1.032) - 1

real risk-free rate=0.036821705

real risk-free rate=3.68%