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NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Introduction to Investment

Which of the following best describes 'real rate of return' on an investment, using the exact (Fisher) relationship?

Real rate of return is the return adjusted for inflation, calculated as (1 + nominal return) divided by (1 + inflation rate) minus 1. It shows the actual growth in purchasing power, unlike the nominal return, which ignores the erosion caused by rising prices.

  1. ANominal return minus the risk-free rate
  2. BReturn after adjusting for inflation, i.e. (1 + nominal)/(1 + inflation) - 1Correct
  3. CNominal return plus the inflation rate
  4. DReturn after deducting taxes and expenses only

Explanation

The real return measures the increase in purchasing power. By the Fisher relationship it equals (1 + nominal return)/(1 + inflation) - 1. Subtracting the risk-free rate gives a risk premium, not a real return, and adding inflation overstates the return.

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