Relation between nominal and real returns and inflation | Finance & Capital Markets | Khan Academy

TL;DR

Learn how to calculate real return on investment by factoring in inflation and nominal interest rates.

Transcript

Let's generalize the mathematics that we've been doing in the last few videos to calculate the real return. And maybe we'll come up with some interesting formulas or some simple approximations. So what we've been doing is we've been, at least in the first video, we converted everything to today's dollars. So the actual dollar return in today's doll... Read More

Key Insights

• ☠️ The formula for calculating real return involves considering both inflation and nominal interest rates.
• 🙃 Adding 1 to both sides of the equation simplifies the calculation.
• 😑 The real return can be expressed as a percentage by multiplying the ratio by 100.

Questions & Answers

Q: How is the dollar return in today's dollars calculated?

The dollar return in today's dollars is determined by subtracting the investment value after inflation from the net dollar return.

Q: What is the formula for calculating real return?

The formula for calculating real return is the dollar return in today's dollars divided by the investment in today's dollars, multiplied by 100 to express it as a percentage.

Q: Why do we divide the numerator and denominator by the original investment?

Dividing the numerator and denominator by the original investment simplifies the equation and allows us to express the real return as a ratio.

Q: How is the real interest rate determined?

The real interest rate is calculated by subtracting the rate of inflation from the nominal interest rate.

Summary & Key Takeaways

• In order to calculate real return, convert everything to today's dollars.

• The net dollar return is the original investment compounded by the nominal interest rate.

• To calculate the real return, divide the dollar return in today's dollars by the investment in today's dollars.