An investment had a nominal return of 9.9 percent last year. The inflation rate was 3.1 percent. What was the real return on the investment?
Question
An investment had a nominal return of 9.9 percent last year. The inflation rate was 3.1 percent. What was the real return on the investment?
Solution
To calculate the real return on an investment, you need to take into account the effect of inflation on the nominal return. The formula to calculate the real return is:
Real Return = ((1 + Nominal Return) / (1 + Inflation Rate)) - 1
In this case, the nominal return is 9.9% or 0.099 (when expressed as a decimal), and the inflation rate is 3.1% or 0.031 (when expressed as a decimal).
So, the real return would be:
Real Return = ((1 + 0.099) / (1 + 0.031)) - 1
First, add 1 to both the nominal return and the inflation rate:
= (1.099 / 1.031) - 1
Then, divide 1.099 by 1.031:
= 1.066 - 1
Finally, subtract 1 from the result:
= 0.066 or 6.6%
So, the real return on the investment, after taking into account the effect of inflation, was 6.6%.
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