A deposit pays a nominal interest rate of 8% a year and inflation is 3% a year. Using the exact Fisher relationship (not the approximation of subtracting inflation from the nominal rate), what is the real rate of interest (to two decimal places)?

Correct answer: D) 4.85%

Explanation

(1 + real rate) = (1 + nominal rate) / (1 + inflation) = 1.08 / 1.03 = 1.048544. Real rate = 4.85% (rounded to two decimal places). 5.00% is the approximation the question excludes, 11.24% multiplies instead of dividing (1.08 x 1.03 - 1) and 4.63% divides the wrong way (1 - 1.03 / 1.08).