Question

An investment offers a total return of 12 percent over the coming year. Janice Yellen thinks the total real return on this investment will be only 7 percent. What does Janice believe the inflation rate will be over the next year?

Answer 1

In simple terms 5%

or

According to Fisher formula 4.67%

Step-by-step explanation:

Nominal rate of return is the inflation adjusted rate of return. Real rate is the rate before inflation. Nominal rate is the sum of real rate and Inflation rate as well.

Simple Method:

Nominal Rate = Real Rate + Inflation Rate

12% = 7% + Inflation Rate

Inflation Rate = 12% - 7%

Inflation Rate = 5%

Using Fisher Effect Formula:

( 1+ n ) = ( 1 + r ) ( 1 + i )

( 1+ 0.12 ) = ( 1 + 0.07 ) ( 1 + i )

1.12 = 1.07 x ( 1 + i )

( 1 + i ) = 1.12 / 1.07

1 + i = 1.467

i = 1.467 - 1

i = 0.467

i = 4.67%