Difference between Nominal and Real Interest Rate – Finance | Management Notes

Difference between Nominal and Real Interest Rate
Finance
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Management Notes

Nominal interest rate is the interest rate that is reported on loan documents and investment accounts which are not adjusted for inflation.Nominal rates represent the rate of exchange between current and future dollars, unadjusted for the effects of inflation. Since nominal rates are not adjusted for inflation, they do not convey the prices of lending and borrowing transactions as accurately as real interest rates, which are adjusted for inflation.A real interest rate is an interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower and the real yield to the lender or to an investor.

S.No.

Nominal Interest Rate

Real Interest Rate

1. A nominal interest rate is the interest rate that does not take inflation into account. A real interest rate is the interest rate that does take inflation into account.
2. Nominal Interest rate shows you the actual price you are paid (or have to pay) if you lend (or borrow) money. ie; it does not account for time value of money. Real Interest rate shows you by how much the actual purchasing power of the money you have in your bank account increases over time. ie; it accounts for time value of money.
3. If inflation is positive then nominal interest rate is higher than real interest rate. If inflation is negative(deflation) then real interest rate is higher than nominal interest rate.
4. Mathematically;

Nominal interest rate = Real interest rate +inflation rate

 Mathematically;

Real interest rate = Nominal interest rate – inflation rate

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