“Opportunity cost”

1. Can the nominal interest rate available to an investor be negative? (Hint: Consider the interest rate earned from saving cash “under the mattress.”) Can the real interest rate be negative?

2. In the early 1980s, inflation was in the double digits and the yield curve sloped sharply downward. What did the yield curve say about investors’ expectations about future inflation rates?

3. What do we mean when we refer to the “opportunity cost” of capital?

 

1. Why aren’t the payments for a 15-year mortgage twice the payments for a 30-year mortgage at the same rate?

2. What mistake do you make when you discount real cash flows with nominal discount rates?

3. How do changes in inflation expectations affect interest rates?

Solution: