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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Time Value of Money

A bank deposit offers a nominal return of 10% per annum while inflation is 6% per annum. What is the approximate real rate of return, calculated using the exact (Fisher) relationship?

The real rate of return is about 3.77%. Using the Fisher relationship, divide 1.10 by 1.06 and subtract one. Simple subtraction gives 4%, but that ignores the compounding effect of inflation on the purchasing power of returns.

  1. A4.00%
  2. B3.64%
  3. C3.77%Correct
  4. D16.60%

Explanation

Real rate = (1 + nominal) / (1 + inflation) - 1 = 1.10 / 1.06 - 1 = 0.0377, i.e. 3.77%. The 4.00% figure comes from simple subtraction, which is only an approximation. The 16.60% figure wrongly multiplies the two factors (1.10 x 1.06).

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