Real Rtn - keeping it real

[CFAhavemercy]

Hi Guys,
The books have 2 formulas for real return
1) Real Return = Nominal Return - Expected Inflation
2) Real Retun = [(1 + Nominal) / (1 + Inflation)] - 1
Depending on the question these will derive a different answer… Does anyone know under what circumstance its best to use each equation???? Thanks in advance to anyone who smart enough to answer…..

 

[krokodilizm]

#2 is the correct formula, but #1 can be used as a close approximation. Depends on how accurate your anwser needs to be.

 

[AmruthSundarkumar]

#1 is equivalent and not equal to. Its an approximation.

 

[CFAhavemercy]

Great, thanks for your replies

 

[theanswer]

You can also put it this way:
(1+nominal) = (1+real) * (1+inflation rate)
1+n=1+r+infl.+r*infl.
asssuming that r*infl. is a small number, therefore it can bee left out and we get:
nominal = real+infl.
the difference between #1 and #2 = real*inflation

 

[S2000magician]

AmruthSundarkumar wrote:#1 is equivalent close to and not equal to. Its an approximation.

FTFY

 

[AmruthSundarkumar]

@S2000magician…. Thanks for that!
I didn’t articulate that well did I!!