Assume that last year your purchased a real asset, say a piece of land, for $50,
ID: 2806845 • Letter: A
Question
Assume that last year your purchased a real asset, say a piece of land, for $50,000. You paid $5,000 down and borrowed the balance. The rate of inflation between last year and this year was 7%. If the value of this asset increased at exactly the rate of inflation, and you sold it 365 days from the time you bought it, the nominal rate of return on your investment was:
63%
Refer to question 19, above. What was the real rate of return on your investment?
7%
Refer to question 19. What would have been your nominal rate of return had you not been leveraged?
70%
Refer to question 19. What would have been your real return had you not been leveraged?
70%Explanation / Answer
Initial price of the land = $50,000
You paid $5,000 down and borrowed the balance
Means your initial investment = $5000
And borrowed fund = $50,000 - $5000 = $45,000
Price of the land after one year = $50,000 *(1+ rate of inflation)
=$50,000 *(1+ 7%)
=$53,500
Therefore your profit (year to year basis) =$53,500 -$50,000 = $3500
(Assumed that you are not paying any interest on your borrowed fund)
1. The nominal rate of return on your investment = Profit / Investment
=$3500/$5000
= 0.70 or 70%
Therefore correct answer is option: 70%
2. The real rate of return on your investment = nominal rate of return on your investment - rate of inflation
= 70% - 7%
= 63%
Therefore correct answer is option: 63%
3. If not leveraged, in that case you will not borrow any fund and whole price of the land will be paid by your own fund.
Your initial investment = Initial price of the land = $50,000
Price of the land after one year = $50,000 *(1+ rate of inflation)
=$50,000 *(1+ 7%)
=$53,500
Therefore your profit (year to year basis) =$53,500 -$50,000 = $3500
And nominal rate of return if you had not been leveraged= Profit / Investment
=$3500/$50,000
= 0.07 or 7%
Therefore correct answer is option: 7%
4. Real rate of return if you had not been leveraged = nominal rate of return if you had not been leveraged - rate of inflation
= 7% - 7%
= 0%
Therefore correct answer is option: 0%