Zane Perelli currently has $100 that he can spend today on socks costing $2.50 each. Alternatively, he could invest the

If Zane spends the $100 on socks, he can buy 40 pairs of socks ($100 ÷ $2.50 per pair). If Zane invests the $100 in the U.S. Treasury security, he will earn a nominal rate of interest of 9%, which means he will have $109 at the end of the year. However, due to inflation, the purchasing power of his $109 will be reduced. The 5% rate of inflation means that prices will increase by 5% over the year. Therefore, Zane's $109 will only be able to buy as much as $103.81 could buy today ($109 ÷ 1.05). This means that Zane's real rate of return is 3.81% ([$103.81 - $100] ÷ $100), which is lower than the nominal rate of 9%. In other words, even though Zane earned a nominal return of 9%, his purchasing power only increased by 3.81% due to inflation.