P Dybvig Investments: Lecture 1, Slide 7, solution (1)

In-line exercise: real returns, solution (1)

If inflation is running at 1%/month, what are the real rates of return to Ursidae Corp for the three months examined in the previous in-class exercise? Recall that the nominal returns were 10%, -20%, and 5%.

approximate:

$R1real ~ 10% - 1% = 9%$

exact:

$R1real ~ (1 + 10%)/(1 + 1%) - 1 ~ 8.911%$

Phil Dybvig

	Using the approximate equation, we subtract 1% from the nominal return of 10% to obtain the real return of 9%. Using the exact equation, we divide 1 plus the return, 1+10%, by 1 plus inflation, 1+1%, and subtract 1, obtaining about 8.911%.
	Press the small right triangle for more of the answer. I recommend trying to solve the rest of the problem first if you have not already done so.