rn = rr + iwhere:
rn = nominal interest rate rr = real interest rate i = projected inflationOther approximations for the nominal interest rate exist.
rn = rr + i + d + mrp + lpwhere
d = default premium (likelihood of default by the borrower) mrp = maturity risk premium (risk factor for length of borrowing period) lp = liquidity premiumIrving Fisher[?] proposed a better approximation of the relationship between nominal interest rate, inflation and real interest rate.
(1 + rn) = (1 + i)(1 + rr)For example: assume the real rate desired is 2% but inflation is running at 5%. Then the lender will charge:
(1 + .05)(1 + .02) = 7.1%
See Also: Term Structure of Interest Rates