There seems to be some inconsistencies on this in what is meant by "expected return". In some cases the return is given gross of inflation and in other cases net. I would argue that the expected return on ILG's is not the real GRY but instead the nominal GRY with an assumption of future inflationary expectations. I would also say the expected return on cash is the nominal short term interest rate, not the real rate. Any thoughts?
Hi Gareth, I agree that it seems inconsistent. But it reflects how these yields are quoted in the financial press. In the Financial Times newspaper, the yield on an index-linked bond is quoted just as a real yield. So you will currently see yields of about 1%-1.5%. However, the yield on a conventional bond is quoted as a nominal yield. So you will currently see yields of about 4% to 5.5%. But you can talk about expected real returns and expected nominal returns on both index-linked and conventional bonds. The real return being the return over and above expected inflation, and the nominal return being the return including inflation. Also, with cash, you can talk about the expected real return (= real short-term interest rates) and the expected nominal return (= nominal short-term interest rates). Typically, we quote interest rates in this country as nominal interest rates, eg the Bank of England base rate is a nominal rate. One place to be careful is when you are equating required and expected returns. Either they both need to be real or both be nominal. So for index-linked bonds, if the GRY is quoted as a real yield, then we equate GRY with rf where rf is the risk-free real rate. For conventional bonds, if the GRY is quoted as a nominal yield, then we equate GRY with rf + exp infl + IRP. Hope this helps.
