Last year, you purchased a stock at a price of $53.60 a share. Over the course of the year, you received $1.50 in dividends and inflation averaged 2.9%. Today, you sold your shares for $55.90 a share. What is your approximate real rate of return on this investment?

Question

Quizplus · Accepted Answer

The real rate of return adjusts the nominal return for the effects of inflation. First, calculate the nominal return: $$ \text{Nominal Return} = \frac{\text{Ending Value} + \text{Dividends} - \text{Beginning Value}}{\text{Beginning Value}} $$ $$ \text{Nominal Return} = \frac{55.90 + 1.50 - 53.60}{53.60} = \frac{3.80}{53.60} \approx 0.0709 \text{ or } 7.09\% $$ Then, adjust for inflation using the formula: $$ \text{Real Rate of Return} = \frac{1 + \text{Nominal Rate}}{1 + \text{Inflation Rate}} - 1 $$ $$ \text{Real Rate of Return} = \frac{1 + 0.0709}{1 + 0.029} - 1 \approx \frac{1.0709}{1.029} - 1 \approx 0.0407 \text{ or } 4.07\% $$ Therefore, the approximate real rate of return is 4.2%, rounding to the nearest tenth.

Last Year, You Purchased a Stock at a Price of $53.60