Real Reverse Nominal Returns
You purchase 100 shares of stock for
$40 a share. The stock pays a $2 per share dividend at year-end. What is the rate of return on your investment for these end-of-year stock prices? What is your real (inflation-adjusted) rated of return? Assume an inflation rate of 4 percent.
a. $38
b. $40
c. $42
2 for each 40 is five percent. If inflation is 4 percent, then one percent is the real return. So 40 cents a share is the real return
I agree with BobP. Are you sure the multiple choices are in dollars and not cents? Could be a misprint.
To calculate the rate of return on your investment, you need to consider both the dividend received and any changes in the stock price. Let's break it down step by step:
Step 1: Calculate the dividend received
Given that you purchased 100 shares at $40 per share, the total cost of your investment is $40 x 100 = $4,000.
Since each share pays a $2 dividend, the total dividend received is $2 x 100 = $200.
Step 2: Calculate the stock price at the end of the year
To determine the rate of return, we need the stock price at the end of the year. However, the question does not provide this information. Without the stock price, we cannot calculate the rate of return accurately.
Step 3: Calculate the nominal rate of return
The nominal rate of return considers only the dividend received. It is calculated by dividing the total dividend received by the initial investment, and then converting it to a percentage.
In this case, the nominal rate of return would be $200 / $4,000 = 0.05, or 5% (since it asks for the rate of return in end-of-year stock prices).
Step 4: Calculate the real rate of return
The real rate of return adjusts for inflation. It accounts for the decrease in purchasing power due to inflation. Given an inflation rate of 4%, we can subtract that from the nominal rate of return to find the real rate of return.
In this case, the real rate of return would be 5% - 4% = 1%.
Regarding the multiple-choice options, you are correct in pointing out that they seem to be in cents rather than dollars. It could be a misprint, as it wouldn't make sense for the options to be in cents when the original investment and dividend are given in dollars.