Security Annual Percentage Return U.S. government T-bills 3.04 Long-term governm

Question

Security

Annual Percentage Return

U.S. government T-bills

3.04

Long-term government bonds

5.75

Long-term corporate bonds

6.80

Large capitalization common stocks

13.50

Small capitalization common stocks

15.60

The annual rate of inflation is 2%.

PLEASE SHOW THE WORK

                  a.               Refer to Exhibit 3.1. What is the real return on long-term corporate bonds?

                  b.               Refer to Exhibit 3.1. What is the T-bill nominal return?

                  c.               Refer to Exhibit 3.1. What is the real return on small capitalization stocks?

                  d.               Refer to Exhibit 3.1. What is the large company stock nominal return?

             e.          Briefly discus the difference between real and nominal returns.

Security

Annual Percentage Return

U.S. government T-bills

3.04

Long-term government bonds

5.75

Long-term corporate bonds

6.80

Large capitalization common stocks

13.50

Small capitalization common stocks

15.60

Explanation / Answer

Fisher says (1+Nominal return)=(1+ inflation)*(1+real return)

A) Real return=(1+Nominal return)/(1+ inflation)-1

=1.068/1.02-1= 5%

B) T Bill Nominal return = 3.04% as inflation already inclusive in it

C)Real return=(1+Nominal return)/(1+ inflation)-1

=1.156/1.02-1=13%

D)Large Cap Nominal return = 13.50%

E. The main difference between real and nominal return in the inflation. In real return effect of inflation is considerred to see if the return receieved will actually increase the dollar value or decrease the dollar value while the nominal return does not check the reffect of inflation. so if we deduct inflation from nominal raeturn we will get real return

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