REAL Inflation

Previously, in our first finance II cla for Q3, our Prof. David Goldriech talked about what happens when a stocks growth rate is larger than it's discount rate, as well as how an annuity calculation works.

Today he spoke about inflation and vindicated an idea I've had that's bothered me since HL Econ at UCC. It was on real versus nominal inflation. We are taught (in the International Baccalaureate and undergraduate levels) that inflation is calculated as:

Nominal = Real + Inflation Rate

However, (as the prof explained) the appropriate way to do it is:

(1 + Nominal Rate) = (1 + Real) x (1 + Inflation)

This is particularly apparent, especially after having built some financial models and looking at why the perpetuity formula works for Terminal Value (with the growth rate pegged at inflation and the discount rate) and noticing that the two scenarios are analogous.