Real Interest Rate

AAA

DEFINITION of 'Real Interest Rate'

An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower, and the real yield to the lender. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate.

Real Interest Rate = Nominal Interest Rate - Inflation (Expected or Actual)

INVESTOPEDIA EXPLAINS 'Real Interest Rate'

The real interest rate is the growth rate of purchasing power derived from an investment. By adjusting the nominal interest rate to compensate for inflation, you are keeping the purchasing power of a given level of capital constant over time.

For example, if you are earning 4% interest per year on the savings in your bank account, and inflation is currently 3% per year, then the real interest rate you are receiving is 1% (4% - 3% = 1%). The real value of your savings will only increase by 1% per year, when purchasing power is taken into consideration.

VIDEO

RELATED TERMS
  1. Nominal Interest Rate

    The interest rate before taking inflation into account. The equation ...
  2. Cox-Ingersoll-Ross Model - CIR ...

    A mathematical formula used to model interest rate movements ...
  3. Auction Rate Bond - ARB

    A debt security with an adjustable interest rate and fixed term ...
  4. Gross Interest

    The annual rate of interest to be paid on an investment, security ...
  5. Inflation

    The rate at which the general level of prices for goods and services ...
  6. Interest Rate

    The amount charged, expressed as a percentage of principal, by ...
Related Articles
  1. Interest Rates: Nominal and Real
    Economics

    Interest Rates: Nominal and Real

  2. What You Should Know About Inflation
    Economics

    What You Should Know About Inflation

  3. Interest Rates And Your Bond Investments
    Investing Basics

    Interest Rates And Your Bond Investments

  4. Why Wages Stick When The Economy Shifts
    Options & Futures

    Why Wages Stick When The Economy Shifts

comments powered by Disqus
Hot Definitions
  1. Ghosting

    An illegal practice whereby two or more market makers collectively attempt to influence and change the price of a stock. ...
  2. Elasticity

    A measure of a variable's sensitivity to a change in another variable. In economics, elasticity refers the degree to which ...
  3. Tangible Common Equity - TCE

    A measure of a company's capital, which is used to evaluate a financial institution's ability to deal with potential losses. ...
  4. Yield To Maturity (YTM)

    The rate of return anticipated on a bond if held until the maturity date. YTM is considered a long-term bond yield expressed ...
  5. Net Present Value Of Growth Opportunities - NPVGO

    A calculation of the net present value of all future cash flows involved with an additional acquisition, or potential acquisition. ...
  6. Gresham's Law

    A monetary principle stating that "bad money drives out good." In currency valuation, Gresham's Law states that if a new ...
Trading Center