Inflation-adjusted returns are an important concept in portfolio performance measurement, as they provide a more accurate representation of an investment's real return by accounting for the effects of inflation.
Which of the following best describes the real return on an investment?
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A) The return before adjusting for inflation is the nominal return. B) The return after adjusting for inflation is the real return. C) The return before adjusting for taxes is irrelevant to real returns. D) The return after adjusting for taxes is irrelevant to real return.
What is the primary purpose of calculating inflation-adjusted returns?
A) Calculating inflation-adjusted returns does not directly determine tax liability. B) Inflation-adjusted returns allow a more accurate investment performance comparison across different time periods. C) Inflation-adjusted returns do not directly measure the risk of an investment. D) Inflation-adjusted returns are not used to calculate the present value of future cash flows.
If an investment has a nominal return of 8% and the inflation rate is 3%, what is the real return on the investment?
A) The real return is calculated by subtracting the inflation rate from the nominal return (8% - 3% = 5%). B) Adding the inflation rate to the nominal return is not the correct calculation for real return. C) Multiplying the nominal return by the inflation rate is not the correct calculation for real return. D) Dividing the nominal return by the inflation rate is not the correct calculation for real return.
In the 1970s, the United States experienced a period of high inflation, with the annual inflation rate reaching double digits. During this time, investors who did not account for inflation in their investment decisions may have believed they were earning positive returns. In reality, their real returns were negative due to the eroding effects of inflation on their purchasing power.
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Example Series 65 Example Practice Question
An investor purchases a bond with a 5% annual yield. If the inflation rate is 2%, the investor's real return on the bond is 3% (5% nominal return - 2% inflation rate).
Inflation-adjusted return = ((1 + Nominal return) / (1 + Inflation rate)) - 1
Suppose an investor has a nominal return of 8% on an investment, and the inflation rate for the same period is 3%. To calculate the inflation-adjusted return, follow these steps: 1. Add 1 to the nominal return: 1 + 0.08 = 1.08 2. Add 1 to the inflation rate: 1 + 0.03 = 1.03 3. Divide the result from step 1 by the result from step 2: 1.08 / 1.03 = 1.0485 4. Subtract 1 from the result in step 3: 1.0485 - 1 = 0.0485 = 4.85%