Wednesday
October 22, 2014

Homework Help: math problem

Posted by Antoinette on Wednesday, March 21, 2007 at 11:54pm.

Real Versus Nominal Returns.

A foreign stock market provided a rate of return of 95 percent. The inflation rate in this country during the year was 80 percent. In the United States, in contrast, the stock market return was only 12 percent, but the inflation rate was only 2 percent.
Which country's stock market provided the higher real rate of return?

The real return in the first country was
1.95/1.80 - 1 = 8.3%

In the US is was 1.12/1.02 -1 = 9.8%

So the US stock market performed better in real terms than the foreign market.

Note that I used division rather than subtracting the inflation % from the rate of return %. That is the correct way to adjust for inflation. Subtracting gives an approximate answer that is not accurate at high inflation rates. It would have resulted in 15% for the foreign stock market and 10% for the US.

ok, thanks.
So if the rate was lower, would it then be ok to subtract it, or is it best to use division no matter the scenerio?

It is best to always use division.

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