Final answer:
The inflation-adjusted return on Investment A, which has a nominal interest rate of 8.0% and an inflation rate of 2.5%, is calculated to be 5.5%. This represents the actual growth in purchasing power from the investment after accounting for inflation.
Step-by-step explanation:
When determining the inflation-adjusted return for an investment, such as Investment A with an interest rate of 8.0%, we must take into account the current inflation rate, which is 2.5%. The real rate of return is the nominal rate (the stated interest rate of 8.0%) adjusted for the inflation rate. Therefore, to calculate the real interest rate, or the inflation-adjusted return for Investment A, you would subtract the inflation rate from the nominal interest rate of Investment A.
The formula is expressed as:
Real Rate of Return = Nominal Rate - Inflation Rate
Using the given rates:
Real Rate of Return = 8.0% - 2.5%
Real Rate of Return = 5.5%
The inflation-adjusted return on Investment A is therefore 5.5%, which represents the true increase in purchasing power derived from the investment, after taking inflation into account.
The real rate of return is the annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external factors. It is the actual annual rate of return after taking into consideration the effects of inflation. By contrast, the inflation-adjusted rate is the rate of return after accounting for the purchasing power of the currency. It adjusts the nominal rate of return to take into account the effect of inflation on the investment's purchasing power.