Canadian Securities Course (CSC) Level 1 Practice Exam

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How is the real rate of return different from the nominal rate of return?

Real rate considers inflation; nominal rate does not
Real rate is always higher than the nominal rate
Nominal rate is adjusted for inflation; real rate is not
Real rate includes only the face value of the bond

The correct answer is: Real rate considers inflation; nominal rate does not

The real rate of return is defined as the return on an investment after adjusting for inflation, while the nominal rate of return is the stated return without any adjustment for inflation. Therefore, the correct answer highlights that the real rate considers the impact of inflation, making it a more accurate reflection of the purchasing power of returns. Inflation erodes the value of money over time, so the nominal rate may give a misleading impression of the actual gain in value. By using the real rate, investors can better understand the true increase in their purchasing power from an investment. The other options do not accurately capture the relationship between the real and nominal rates. The second option incorrectly asserts that the real rate is always higher, which is not the case, especially in scenarios of high inflation. The third option reverses the definitions of the real and nominal rates, and the fourth option is not relevant because it pertains to specific bonds rather than the general concept of rates of return.