CFA Level I · CFA Level I Exam · Types of Financial Returns
An investor earns a nominal return of 8.0% in a year when inflation is 3.0%. The real return is closest to:
The real return is about 4.85%. It is found by dividing the nominal growth factor of 1.08 by the inflation factor of 1.03 and subtracting one. Simple subtraction gives 5.00%, which overstates the real return because it ignores the interaction between the two rates.
- A4.85%Correct
- B5.00%
- C11.24%
Explanation
Real return = (1.08 / 1.03) − 1 = 1.04854 − 1 = 4.85%. The 5.00% option simply subtracts inflation from the nominal return, which ignores compounding. The 11.24% option multiplies the two factors instead of dividing.
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