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### 13 Cards in this Set

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• Back
 RISK PREMIUM (1 + r )=(1 + rrisk free )(1 +ρ), ρ is called the risk premium real interest rate (1 + r )=(amount returned) /(amount lent) THE NOMINAL INTEREST RATE is (1 + i)= (Payment on the Loan) / (Value of the Loan) Payment on the Loan = (# goods sold)*(Priceof good) Value of the Loan = (#goods bought)*(price of good) Consumption C(t) = R(t) − I(t) if t>T and C(t) = R(t) − I(t) − (Seeds used to pay loan and interest)(t), if t=T Ct = consumption in year t Rt = return in year t It = interest in year t three sources of fluctuation for the nominal interest rate. (1 + i)= (1 +πs )(1 + rrf )(1 +ρ) r = real interest rate (flux) πs = product inflation ρ = risk For small countries with relatively low inflation rates, how is real interest rate related to the nominal interest rate and inflation. r ≈ i − π, where i = nominal interst, r = real interest, π = inflation rate ref. Fisher Effect how does nominal interest behave in the long, medium and short terms? In the long run inflation is equal to the growth rate of money minus the normal growth rate. Hence, in the medium term i ≈ rn + gm − gy but in the short term e i ≈ r +π FISHER EFFECT. The hypothesis that in the long term, the nominal interest rate increases with the inflation rate. Equilibrium in the goods market was represented by the IS curve. Y = A(Y , r) + A and in the medium term Y=Yn, hence there is, for every set of parameters of function A (marginal propensity to consume, sensitivity of investment to the interest rate) and for every level of autonomous spending (government spending) a NATURAL REAL INTEREST RATE rn . PRESENT DISCOUNTED VALUE (PDV). x_t = return flow at year t {x_t E t=0…..n} K = investment during first period PDV = x_0 + SUM[x_t /(Prod(1+i_T,from T=1 to T=t))] - K Assuming a constant interest rate ( i ) and return rate (x) yields PDV of : PDV = x + x/i - K