If the nominal interest rate is 4.00% and inflation is 2.25%, what is the real interest rate?

To find the real interest rate when given the nominal interest rate and the inflation rate, the Fisher equation is typically used. This equation states that the real interest rate can be calculated by subtracting the inflation rate from the nominal interest rate.

In this case, the nominal interest rate is 4.00% and the inflation rate is 2.25%. To calculate the real interest rate:

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Real Interest Rate = 4.00% - 2.25%

Real Interest Rate = 1.75%

This calculation shows that the real interest rate is indeed 1.75%. Understanding how the nominal interest rate adjusts for inflation is crucial in investment practice, as it reflects the true purchasing power of the returns on investments. Therefore, the correct answer reflects the accurate relationship between nominal interest rates and inflation, enabling investors to gauge the actual yield they are receiving on their investments.