Math Problem Statement
Question 12 You estimate that an investment of yours has generated a nominal rate of return of 14% p.a. Over that same period of time, inflation has increased at a rate of 4% p.a. Which of the following is closest to your real rate of return p.a.? (a) 8.65% (b) 9.62% (c) 11.76% (d) 17.52%
Solution
To calculate the real rate of return when given the nominal rate of return and the inflation rate, we use the Fisher equation, which adjusts for inflation as follows:
Where:
- Nominal rate = 14% (0.14)
- Inflation rate = 4% (0.04)
Now, plugging these into the formula:
Now let's compute this:
So, the closest option to your real rate of return is (b) 9.62%.
Would you like more details or have any questions?
Related questions:
- How does the Fisher equation account for inflation?
- What would happen if inflation was higher than the nominal rate of return?
- How is the nominal rate of return typically calculated for investments?
- Can the real rate of return be negative? What does that mean for an investment?
- How does compound inflation impact long-term investments?
Tip:
Always use the real rate of return to assess your investment's true profitability, as it accounts for the eroding effect of inflation.
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Math Problem Analysis
Mathematical Concepts
Financial Mathematics
Inflation Adjustment
Real Rate of Return
Formulas
Real Rate of Return = (1 + Nominal Rate) / (1 + Inflation Rate) - 1
Theorems
Fisher Equation
Suitable Grade Level
Undergraduate level (Financial Mathematics, Economics)
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