Chapter 12 Page 343 P6 Find The Real Return On The Following

Chapter 12 Page 343 P6find The Real Return On The Following Investme

Chapter 12, page 343, P6 Find the real return on the following investments. STOCK NOMINAL RETURN INFLATION A 10% 3% B 15% 8% C – 5% 2% Stock A- 10%-?%=?% Stock B- 15%-?%=?% Stock C- 5%-?%=?%

Paper For Above instruction

Introduction

The concept of real return is fundamental in investment analysis, as it measures the actual purchasing power of investment returns by adjusting nominal returns for inflation. This adjustment provides a clearer picture of an investor's true gains over a specific period. Understanding how to calculate real returns helps investors make informed decisions that account for erosion of value due to inflation.

Calculating Real Returns

The standard formula used to compute the real return is given by:

Real Return = Nominal Return – Inflation Rate

Alternatively, for more precise calculations, especially with higher inflation rates, the Fisher Equation is used:

Real Return ≈ (1 + Nominal Return) / (1 + Inflation Rate) – 1

However, given the simplicity and small inflation rates in this context, the subtraction method provides sufficient accuracy.

Analysis of Investment Options

For Stock A:

  • Nominal Return: 10%
  • Inflation Rate: 3%
  • Real Return: 10% - 3% = 7%

Hence, after adjusting for inflation, the real return on Stock A is approximately 7%.

For Stock B:

  • Nominal Return: 15%
  • Inflation Rate: 8%
  • Real Return: 15% - 8% = 7%

Similarly, Stock B’s real return is roughly 7%, which indicates the purchasing power increase is equivalent to 7% after inflation adjustment.

For Stock C, which has a negative nominal return:

  • Nominal Return: -5%
  • Inflation Rate: 2%
  • Real Return: -5% - 2% = -7%

This indicates the investor’s purchasing power declines by 7% after accounting for inflation, reflecting a real loss.

Summary of Findings:

  • Stock A: Real return = 7%
  • Stock B: Real return = 7%
  • Stock C: Real return = -7%

These calculations highlight how inflation erodes nominal gains—sometimes even turning positive nominal returns into negative real returns, particularly in the case of Stock C.

Conclusion:

Understanding and calculating the real return on investments enables investors to accurately gauge the true profitability of their investment choices after inflation is considered. Both Stock A and Stock B provide a real return of approximately 7%, making them comparable in terms of real growth prospects, despite differing nominal returns. Conversely, Stock C’s negative real return underscores the importance of considering inflation when evaluating investment performance, especially for assets with negative nominal returns.

References

  • Bodie, Z., Kane, A., & Marcus, A. J. (2014). Investments (10th ed.). McGraw-Hill Education.

Related Assignments