Frank is lending $1,000 to Sarah for two years. Frank and Sarah agree that Frank should earn a real return of 2 percent per year.

a.The CPI (times 100) is 100 at the time that Frank makes the loan. It is expected to be 104 in one year and 108.2 in two years. What nominal rate of interest should Frank charge Sarah?

b.Suppose Frank and Sarah are unsure about what the CPI will be in two years. How should Frank index Sarah's annual repayments to ensure that he gets an annual 2 percent rate of return?