Question

You are given the following long-run annual rates of return for alternative investment instruments: U.S. Government T-bills 3.80 % Large-cap common stock 11.65 Long-term corporate bonds 5.35 Long-term government bonds 4.40 Small-capitalization common stock 12.70 The annual rate of inflation during this period was 2 percent. Compute the real rate of return on these investment alternatives. Do not round intermediate calculations. Round your answers to two decimal places.

Answer 1

0.0176

0.0946

0.0328

0.0235

0.1049

Step-by-step explanation:

The formular that is used to calculate the real rate of return is

(1+return)/(1+inflation) -1

The real rate of return for U.S. Government T-bills 3.80% can be calculated as follows

Inflation rate = 2%

Return= 3.80%

Real rate of return= (1+3.80/100) / (1+2/100)

= (1+0.038)/(1+0.02) -1

= 1.038/1.02 -1

= 1.0176 -1

= 0.0176

The real rate of return for large cap common stock 11.65% can be calculated as follows

Inflation rate= 2%

Return= 11.65%

Real rate of return= (1+11.65/100)/(1+2/100)-1

= (1+0.1165)/(1+0.02)-1

= 1.1165/1.02 -1

= 1.0946 -1

= 0.0946

The real rate of return for long term corporate bond 5.35% can be calculated as follows

Inflation rate= 2%

Return= 5.35%

Real rate of return= (1+5.35/100)/(1+2/100) -1

(1+0.0535)/(1+0.02) -1

1.0535/1.02 -1

= 1.0328 -1

= 0.0328

The real rate of return for long term government bond 4.40%

Inflation= 2%

Return= 4.40%

Real rate of return= (1+4.40/100)/(1+2/100) -1

= (1+0.044)/(1+0.02) -1

= 1.044/1.02 -1

= 1.0235-1

= 0.0235

The real rate of return for small capitalization common stock 12.70% can be calculated as follows

Inflation rate= 2%

Return= 12.70%

Real rate of return= (1+12.70/100)/(1+2/100) -1

= (1+0.127)/(1+0.02) -1

= 1.127/1.02 -1

= 1.1049-1

= 0.1049