Canadian Securities Course (CSC) Level 2 Practice Exam

How is the real rate of return calculated?

1. Nominal rate plus inflation

2. Inflation subtracted from the nominal rate

3. Real rate multiplied by inflation

4. Real rate divided by inflation

The correct answer is: Inflation subtracted from the nominal rate

The correct approach to calculating the real rate of return is to subtract the rate of inflation from the nominal rate. This formula helps investors understand the actual purchasing power of their returns after accounting for inflation. The nominal rate represents the observed return on an investment, but it does not reflect the decrease in purchasing power caused by rising prices. By subtracting inflation, you arrive at the real rate, which indicates the true increase in wealth or value an investor can expect from their investment. Understanding this concept is crucial for making informed investment decisions, as it provides a clearer picture of how much an investment truly earns after factoring in the economic effects of inflation over time.