In: Finance
Say you own an asset that had a total return last year of 18.5 percent. If the inflation rate last year was 3 percent, what was your real return?
Solution: | |||
Real return was 15.05 % on the asset owned | |||
Working Notes: | |||
Notes: | To know the real rate of return on the asset we have to use Fisher effect formula , where total return will be nominal rate of interest earned . | ||
As per Fisher effect | |||
(1+ real rate) (1+inflation) = (1+ nominal rate of interest) | |||
where real rate is constant | |||
nominal rate of interest = total return earned =18.5% | |||
Real rate of return = ?? | |||
Inflation rate = 3% | |||
hence | |||
(1+ real rate) (1+inflation) = (1+ nominal rate of interest) | |||
(1+ real rate) (1+ 3%) = (1+ 18.5%) | |||
(1+ real rate) (1.03) = (1.185) | |||
Real rate r = (1.185/1.03) - 1 | |||
Real rate r = 0.150485437 | |||
Real rate r = 15.0485437% | |||
Real rate r = 15.05% | |||