The pure rate of interest is 4 percent. Investors require an inflation premium is 2.5 percent and a risk premium of 3 percent to invest in the stock of a company. What is the real rate?

Inflation is factored into the real interest rate. Investors are required to pay an inflation and risk premium in order to purchase a stock. In this example, the rate of pure interest is 4 percent. The risk premium equals 3 percent while the inflation premium amounts to 2.5 percent. These two premiums, when added together, equal 5.5 percent (2 + 3 = 5). Subtracting this from the pure rate of interest gives us an estimated real rate of -1.5 percent (-4 – 5.5 = -1.5). This means that when investing in this particular company’s stock, investors can expect to receive approximately 1.5 percent less return than they would if there were no premiums involved due to factors such as inflation or risk associated with the investment.

This real rate can be used by potential investors in order to determine whether or not it will be worth investing in this company’s stock given current market conditions and their own individual goals for returns on investments made. Additionally, companies may use this information to decide how much money they should be willing to pay out in dividends/interest payments as well as set prices for their products/services based off expected consumer demand levels related to affordability & perceived value balances given current market rates.