Question

Which option is correct for Nominal return?
(a)Real rate of return – Inflation
(b)Real rate of return + Inflation
(c)Inflation – Real rate of return
(d)None of these

Answer 1

Hint: Nominal rate of return strips off all the outside factors that affect the performance such as (taxes and inflation). So, we can say that nominal return is the subtraction of inflation or taxes from the real rate of return. Using this information, find the option which is closest to this information.

Complete step by step answer:
In the above problem, we are asked to find the relation between the nominal rate of return, the real rate of return, and inflation.
We know that the nominal rate of return strips out (or removes) the outside factors (such as taxes and inflation) so the information we can infer from this statement is that the nominal rate of return is the subtraction of inflation (or taxes) from the real rate of return.
To get a better understanding of what we have just stated let us take an example in which if an investment earned over $10\mathrm{\%}$ in one year and the rate of inflation is $3\mathrm{\%}$ that year then the nominal rate of return is equal to the subtraction of $3\mathrm{\%}$ from $10\mathrm{\%}$ which will give the nominal rate of return as:
$\begin{array}{rl}& 10\mathrm{\%}-3\mathrm{\%}\\ & =7\mathrm{\%}\end{array}$
 From the above, we can say that the Nominal rate of return is equal to the subtraction of inflation from the real rate of return.
With this information, we have come to a conclusion that the correct option is (a).

So, the correct answer is “Option a”.

Note: The point to be noted here is that although the nominal rate of return does not include inflation or taxes still we put it in tandem with the real rate of return because it gives the information that the performance of an investment is not eroded by inflation or taxes.