Real Rtn - keeping it real

CFA Level II
#1

Hi Guys,

The books have 2 formulas for real return

  1. Real Return = Nominal Return - Expected Inflation

  2. Real Retun = [(1 + Nominal) / (1 + Inflation)] - 1

Depending on the question these will derive a different answer… Does anyone know under what circumstance its best to use each equation??? Thanks in advance to anyone who smart enough to answer…

#2

#2 is the correct formula, but #1 can be used as a close approximation. Depends on how accurate your anwser needs to be.

#3

#1 is equivalent and not equal to. Its an approximation.

#4

Great, thanks for your replies

#5

You can also put it this way:

(1+nominal) = (1+real) * (1+inflation rate)

1+n=1+r+infl.+r*infl.

asssuming that r*infl. is a small number, therefore it can bee left out and we get:

nominal = real+infl.

the difference between #1 and #2 = real*inflation

#6

FTFY

#7

@S2000magician… Thanks for that! :slight_smile: I didn’t articulate that well did I!!