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Discussion

A real discount rate differs from a nominal one in that the real rate

  • A.applies only to borrowed money
  • B.excludes inflation
  • C.includes inflation
  • D.is always the higher of the two

Answer: B

Correct answer: excludes inflation

A real rate is a nominal rate with inflation stripped out, so it is the lower of the two. The rule that follows is one of consistency: real cash flows must be discounted at a real rate and inflated ones at a nominal rate, and mixing the two overstates or understates the result systematically.

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