The market interest rate i sub f is 10 per year compunded se

The market interest rate (i sub f) is 10% per year, compunded semianuually. For an inflation of 2% per 6 months, the effective semi annual interest rate is closest to:

(a) 2% (b) 3% (c) 4% (d) 6%

how to solve this ?

Solution

Market interest rate=10% compounded semiannually

Semi annual market interest rate=0.1/2=0.05=5%

Semiannual inflation=2%

Thus effective semiannual real interest rate=5%-2%=3%

Hence Option B