If the inflation rate is 5 percent and a $1000 bank deposit increases in one year to $1120, then the real interest rate for that deposit is ...

a. 12 percent

b. 12.5 percent

c. 7 percent

d. 7.2 percent

c. 7 percent

Explanation:

The real interest rate will be net of the effect of inflation.

In this case we are givne with the principal and the amount.

We will solve for nominal rate first:

amount / principal - 1 = rate

1,120/1,000 - 1 = 0.12

Now, we calculate the real rate of return. we subtract the inflation from the nominal to achieve the real rate.

nominal - inflation = real rate

0.12 - 0.5 = 0.07

The real interest rate will be of 0.07 = 7%