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%

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:

\[
\text{Real Rate of Return} = \frac{1 + \text{Nominal Rate}}{1 + \text{Inflation Rate}} - 1
\]

Where:
- Nominal rate = 14% (0.14)
- Inflation rate = 4% (0.04)

Now, plugging these into the formula:

\[
\text{Real Rate of Return} = \frac{1 + 0.14}{1 + 0.04} - 1
\]

\[
\text{Real Rate of Return} = \frac{1.14}{1.04} - 1
\]

Now let's compute this:

\[
\text{Real Rate of Return} = 1.09615 - 1 = 0.09615 \approx 9.62\%
\]

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:
1. How does the Fisher equation account for inflation?
2. What would happen if inflation was higher than the nominal rate of return?
3. How is the nominal rate of return typically calculated for investments?
4. Can the real rate of return be negative? What does that mean for an investment?
5. 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.

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%

Discover how to calculate the real rate of return using the Fisher equation. With a nominal rate of 14% and an inflation rate of 4%, learn the step-by-step process to find the real rate of return, which is closest to 9.62%. This solution is ideal for finance and economics students at the undergraduate level.

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