Question

Currently the CPI is growing at 2% per year and you expect it to remain so for the near future. Suppose you have two investment opportunities. The first one would give you a nominal annual return of 10% for the next 3 years while the second one would give you a real annual return of 8% for the same period. Which one of the following statements is correct?   

A.   The first one is a better option.                                     

B.   The second one is a better option.

C.   Both have the same nominal annual return.

D. Both have the same real annual return.

E.   None of the above.

Answer 1

- Inflation rate (CPI) = 2%

Investment one will have a nominal rate of return = 10%

Formula for : Real rate of Return = [(1+Nominal rate of Return)/(1+Inflation rate)]-1

=[(1+0.10)/(1+0.20)] - 1

= 7.84%

Investment two will have a nominal rate of return = 8%

Formula for : Real rate of Return = [(1+Nominal rate of Return)/(1+Inflation rate)]-1

=[(1+0.08)/(1+0.20)] - 1

= 5.88%

So, the real rate of return of Investment One is better.

hemce, option A The first one is a better option

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