Final answer:
The expected rate of return refers to the projected return on an investment, while risk measures the uncertainty of its profitability. The actual rate of return includes capital gains and interest at the end of a time period. The real interest rate adjusts the interest rate for inflation.
Step-by-step explanation:
The expected rate of return refers to how much a project or an investment is expected to return to the investor, either in future interest payments, capital gains, or increased profitability. It is usually the average return over a period of time, usually in years or even decades. The risk measures the uncertainty of that project's profitability, including default risk and interest rate risk. Default risk is the risk that the borrower fails to pay back the bond or loan, while interest rate risk is the danger of buying a long-term bond at a lower interest rate before market rates rise.
A high-risk investment is one that has a wide range of potential payoffs, while a low-risk investment may have actual returns that are fairly close to its expected rate of return year after year. The actual rate of return refers to the total rate of return, including capital gains and interest paid, at the end of a time period.
For example, if an investment has an expected rate of return of 6%, but in some months or years, the actual rate of return may be much higher or lower than 6%. The real interest rate refers to the interest rate adjusted for inflation, which gives a more accurate measure of the purchasing power of the return on an investment.
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