Real versus nominal returns. you purchase 100 shares of stock for $40 a share. the stock pays a $2 per share dividend at year-end. (lo11-2) a. what is the rate of return on your investment if the end-of-year stock price is (i) $38; (ii) $40; (iii) $42b. what is your real (inflation-adjusted) rate of return if the inflation rate is 3%?

a.

(i)  Rate of return=(2+(38-40))/20=0%

(ii) Rate of return=(2+(40-40))/20=10%

(iii)Rate of return=(2+(42-40))/20=20%

b.

(i) Real rate of return=(1+0%/1+3%)-1=0%

(ii) Real rate of return=(1+10%/1+3%)-1=6.8%

(iii) Real rate of return=(1+20%/1+3%)-1=16.50%

Explanation:

a. The return on any stock can be calculated using the below formula

Return=(Dividend+Capital gain)/Opening value of stock

Where Capital gain=Closing value of stock- opening value of stock.

Using the formula above

(i)  Rate of return=(2+(38-40))/20=0%

(ii) Rate of return=(2+(40-40))/20=10%

(iii)Rate of return=(2+(42-40))/20=20%

b. The Real rate of return can be calculated using the below formula:

Real rate of return=(1+ rate of return/1+inflation rate)-1

(i) Real rate of return=(1+0%/1+3%)-1=0%

(ii) Real rate of return=(1+10%/1+3%)-1=6.8%

(iii) Real rate of return=(1+20%/1+3%)-1=16.50%

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