Suppose Bob considers borrowing $100 from Sheila at a 10 percent interest rate. They both think that a 4 percent real interest rate would be fair.

a) What was the inflation rate they both expected?(1 mark)

b) If the inflation rate turned out to be 8 percent, how much was the real interest rate? Who gained and who lost from this transaction, and how much because of unexpected inflation?(2 marks)

c) If there was an interest tax of 30 percent, what is the after-tax real interest rate, with the inflation rate of 8 percent?(2 marks)