Question

An investment offers a total return of 11 percent over the coming year. Janet Jello thinks the total real return on this investment will be only 7.4 percent. What does Janet believe the inflation rate will be over the next year

Answer 1

Using Fisher Effect, the Inflation Rate will be calculated as follows

Inflation Rate = [(1 + Nominal Rate) / (1 + Real Rate)] – 1

Nominal Interest Rate = 11%

Real Rate of Return = 7.40%

Inflation Rate = ?

Therefore, the Inflation Rate = [(1 + Nominal Rate) / (1 + Real Rate)] – 1

= [(1 + 0.11) / (1 + 0.0740)] – 1

= [1.11 / 1.074] – 1

= 1.0335 – 1

= 0.0335 or

= 3.35% (Rounded to 2 decimal place)

“Therefore, the inflation rate over the next year would be 3.35%”