1.

As a rule of thumb, real rates of interest are calculated by subtracting the inflation rate
from the nominal rate. What is the error from using this rule of thumb for calculating
real rates of return in the following cases?

Nominal rate (%) 7 12 18 22

Inflation rate (%) 4 6 8 10

Solution:

Nominal rate(%)(NR) 7 12 18 22
Inflation rate(%) ( IR) 4 6 8 10
Real rate by the rule of thumb(%) 3 6 10 12

Correct rate(%)=(1+NR)/(1+IR)-1 2.88 5.66 9.26 10.91

Error from using the rule of thumb(%) 0.12 0.34 0.74 1.09

2. As a rule of thumb, real rates of interest are calculated by subtracting the inflation rate
from the nominal rate. What is the error from using this rule of thumb for calculating
real rates of return in the following cases?

Nominal rate (%) 4 8 11 19

Inflation rate (%) 1 3 2 4

Solution:

Nominal rate(%)(NR) 4 8 11 19
Inflation rate(%) ( IR) 1 3 2 4
Real rate by the rule of thumb(%) 3 5 9 15

Correct rate(%)=(1+NR)/(1+IR)-1 2.97 4.85 8.82 14.42

Error from using the rule of thumb(%) 0.03 0.15 0.18 0.58