CFA Level I · CFA Level I Exam · Returns of Financial Assets and Instruments
An investor earns a nominal return of 6.0% in a year when inflation is 2.5%. Using the exact relationship, the real return is closest to:
The real return is about 3.4%. Dividing one plus the nominal return by one plus inflation, 1.06 divided by 1.025, gives 1.0341, so the real return is 3.41%. Simply subtracting inflation gives 3.5%, which is only an approximation.
- A3.4%Correct
- B3.5%
- C8.6%
Explanation
Real return = (1 + 0.06)/(1 + 0.025) - 1 = 1.06/1.025 - 1 = 0.03415, or about 3.4%. Simple subtraction gives 3.5%, which ignores compounding. Adding the rates gives 8.6%, which is a sign error.
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