Assuming that the inflation rate and risk-free rate of interest are relatively high, which of the following correctly illustrates the calculation of the nominal risk-free rate?
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A. B. C. D. E. F.A
When either the real "inflation-free" interest rate or the expected inflation rate are significantly large, the calculation of the nominal risk-free rate differs from the equation used when these factors are significantly small. Specifically, the calculation of the nominal risk-free rate of interest when the inflation-free rate of interest and/or the inflation premium are significantly high is as follows:
Nominal RFR = (1 + Real RFR)(1 + E(I)) - 1
Where: Real RFR = the real inflation-free rate of interest and E(I) = the anticipated inflation rate.
When the inflation-free rate of interest and/or the inflation premium are low, then the equation above can be approximated by the following:
Nominal RFR = Real RFR + Inflation premium.