Question

Say you own an asset that had a total return last year of 15 percent. Assume the inflation rate last year was 4.3 percent. What was your real return?

a) 10.77%

b) 11.57%

c) 10.90%

d) 11.25%

Answer 1

The real return on the asset last year was 10.90%.so the correct answer is c) 10.90%.

Step-by-step explanation:

To calculate the real return, we use the formula: Real Return =
`\(\frac{{1 + \text{{Total Return}}}}{{1 + \text{{Inflation Rate}}}} - 1\).`

Given:

Total Return = 15%

Inflation Rate = 4.3%

Real Return =
`\(\frac{{1 + 0.15}}{{1 + 0.043}} - 1\)`

Real Return ≈
`\(\frac{{1.15}}{{1.043}} - 1\)`

Real Return ≈ 1.1019 - 1

Real Return ≈ 0.1019

Converting 0.1019 to a percentage gives the real return as approximately 10.19%. Therefore, the real return on the asset last year was approximately 10.19%.

The real return formula subtracts the inflation rate from the total return to determine the actual gain in purchasing power. In this case, the total return of 15% needs adjustment to factor in the inflation rate of 4.3%. Using the formula
`\(Real Return = \frac{{1 + \text{{Total Return}}}}{{1 + \text{{Inflation Rate}}}} - 1\)`, the calculations result in a real return of approximately 10.19%. This figure represents the actual increase in the asset's value when considering the impact of inflation.

This calculation is crucial to understand the genuine growth or decline in the asset's value concerning the purchasing power. Inflation diminishes the real purchasing power of returns, hence the necessity to compute the real return. In this case, after accounting for the 4.3% inflation rate, the actual gain on the asset was approximately 10.19%, highlighting the importance of factoring in inflation when evaluating investment performance.

Understanding the real return assists investors in making informed decisions by providing a clearer picture of the actual value gained or lost on an asset after considering the impact of inflation. In this scenario, the asset's apparent 15% return was adjusted to approximately 10.19% real return, offering a more accurate assessment of its performance in retaining or increasing purchasing power.