R02 Real and nominal returns: free practice questions

1. Question 1 of 5

   What is a real return?

   Option A: A return measured before deducting inflationOption B: A return adjusted to take account of inflationOption C: A return measured after deducting income taxOption D: A return from property investment

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   The answer is B: A return adjusted to take account of inflation

   Real returns are nominal returns adjusted for inflation. They show the change in an investment's purchasing power.

   Why the other options are wrong

   A

   That's a nominal return.

   C

   That's a net return.

   D

   Real here refers to inflation, not real estate.

2. Question 2 of 5

   A client wants a real return of 3% a year. Inflation is forecast at 3.5%. Roughly what nominal return is needed?

   Option A: 3.0%Option B: 0.5%, as inflation exceeds the targetOption C: 6.5%Option D: Nothing, as inflation exceeds the target

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   The answer is C: 6.5%

   Rearranging the formula: nominal ≈ real + inflation = 3% + 3.5% = 6.5%.

   Why the other options are wrong

   A

   That's the real target, before adding inflation.

   B

   That deducts the real return from inflation.

   D

   A real target still needs a nominal return above inflation.

3. Question 3 of 5

   Fund A returned 6% in a year with 1% inflation. Fund B returned 8% in a later year with 5% inflation. Which delivered the higher approximate real return?

   Option A: Fund B, with about 5% against 3%Option B: Fund B, with the higher nominal returnOption C: Fund A, with about 5% against 3%Option D: They delivered the same real return

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   The answer is C: Fund A, with about 5% against 3%

   Fund A: 6% − 1% ≈ 5% real. Fund B: 8% − 5% ≈ 3% real. A higher nominal return doesn't always mean a higher real return.

   Why the other options are wrong

   A

   The figures are the other way round.

   B

   Nominal returns ignore the different inflation rates.

   D

   The real returns are about 5% and 3%.

4. Question 4 of 5

   A cautious client keeps all her savings in cash earning 3.75%, while inflation runs at 4.25%. What is happening to her savings?

   Option A: Their real value is rising by 8% a yearOption B: Their purchasing power is slowly fallingOption C: They're fully protected because cash can't fall in valueOption D: Their real value is rising by 3.75% a year

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   The answer is B: Their purchasing power is slowly falling

   Real return ≈ 3.75% − 4.25% = −0.5%. The nominal balance rises, but it buys less each year: this is inflation risk on cash.

   Why the other options are wrong

   A

   That adds inflation to the interest.

   C

   Cash can lose real value to inflation.

   D

   That ignores inflation.

5. Question 5 of 5

   Why is the formula 'nominal return minus inflation' described as approximate?

   Option A: Nominal returns can't be measured preciselyOption B: Inflation figures are always estimatedOption C: It's a simplification of the exact relationshipOption D: It only works for cash deposits

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   The answer is C: It's a simplification of the exact relationship

   Subtracting inflation from the nominal return gives an approximate real return. It's simple and close enough for most purposes, especially at low rates.

   Why the other options are wrong

   A

   They can be measured from prices and income.

   B

   The formula is approximate even with known inflation.

   D

   It can be applied to any investment.

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