Interest and inflation (1 Viewer)

[sandersen]

How can a loan of $100 with interest of 2% and inflation of 5% have a real repay of $97.14. Where did the .14 come from?

Diagram attached if it makes it clearer

 

[Trebla]

How can a loan of $100 with interest of 2% and inflation of 5% have a real repay of $97.14. Where did the .14 come from?

Diagram attached if it makes it clearer

(1 + real interest rate) x (1 + inflation rate) = (1 + nominal interest rate)
=> (1 + real interest rate) = (1 + nominal interest rate) / (1 + inflation rate)
1 + real interest rate = 1.02/1.05
"real interest rate" = - 0.02857....
So $100 investment gives a real repayment of:
100 x (1 + - 0.02857) = $97.14