W98NOONMT.2

2. A friend wants to borrow $100 from you. She promises to pay you back $115 in two years.

1. What annual interest rate is she offering you? (4 pts.)

   

    b. If you have a bank account that pays 5%, compounded quarterly, is the loan a good deal for you (assume that you can be sure that she will pay you back)? (4 pts.)

   First you must find the effective annual rate for the bank's offer:
   , so loaning to your friend offers a higher rate of return.

    c. If you expect inflation to be 3% per year (annual compounding), what real rates of return are you earning on the loan and your bank account? (6 pts.)
    

    , so you're earning 4.11% and 2.03%.
    

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