IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Allowing for inflation
An investor in Pune earns a money effective annual return of 9.18% while inflation runs at 3% per year. What is the real effective annual rate of return?
The real effective annual return is 6.00%. Divide the money growth factor 1.0918 by the inflation factor 1.03 to get 1.06. Simply subtracting 3% from 9.18% gives 6.18%, which is only an approximation and is not exact.
- A6.18%
- B6.00%Correct
- C6.38%
- D5.82%
- 12.18%
Explanation
Real rate = 1.0918/1.03 - 1 = 1.06 - 1 = 6.00%. Subtracting 3% from 9.18% gives 6.18%, which ignores the compounding link between the rates. Dividing by the wrong factor, 9.18/1.03 style errors, give other values.
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