One year ago, you bought a bond for $10,000. You received interest of $400 at the end of the year, as well as your $10,000 principal. If the inflation rate over the last year was five percent, calculate the real return.
To calculate the real return, you need to adjust the nominal return (interest received) for inflation. Here's how you can do it:
1. Calculate the nominal return: This is the total return you received, which is the sum of the interest and the principal. In this case, the nominal return is $400 (interest) + $10,000 (principal) = $10,400.
2. Calculate the inflation-adjusted return: To account for inflation, you need to deduct the inflation rate from the nominal return. In this case, the inflation rate is 5 percent. To calculate this, you multiply the nominal return by (1 - inflation rate). So, the inflation-adjusted return is $10,400 * (1 - 0.05) = $10,400 * 0.95 = $9,880.
3. Calculate the real return: The real return is the inflation-adjusted return minus the initial principal. In this case, the real return is $9,880 (inflation-adjusted return) - $10,000 (principal) = -$120.
So, the real return on your investment over the past year is -$120, indicating a negative return after adjusting for inflation.