What's the difference between nominal yield and real yield, and how do I convert?

Question

AcadiFi · Accepted Answer

Nominal yield is the stated yield including expected inflation; real yield is the inflation-adjusted yield measuring purchasing-power return. The Fisher equation links them: (1 + nominal) = (1 + real) × (1 + expected inflation), or approximately nominal ≈ real + expected inflation. Example: The 10-year Treasury yields 4.20% (nominal); 10-year TIPS yields 1.85% (real). Breakeven inflation = (1.042 / 1.0185) − 1 = 2.308% — the market's pricing of average inflation over 10 years. If realized inflation exceeds 2.308%, TIPS outperform; below, nominal Treasuries outperform. Conversion direction: nominal → real using realized or expected inflation. Example: Cotsworth Pension holds a 10-year corporate bond yielding 5.40% nominal. Expected inflation over the holding period is 2.80%. Real yield = (1.054 / 1.028) − 1 = 2.53%. After-inflation purchasing power grows at 2.53% annually. Note: TIPS coupons and principal are adjusted by CPI — what TIPS quotes as 'real yield' is truly ex-ante real. Nominal Treasury yields embed an inflation risk premium (IRP) investors demand for bearing uncertain inflation; breakeven = expected inflation + IRP. Analysts separate these using surveys (e.g., Fed SCP, Michigan, SPF) or model-implied IRP. Using real yields in discounted cash flow: discount real cash flows at real rates; discount nominal cash flows at nominal rates — mixing the two is a classic error.

What's the difference between nominal yield and real yield, and how do I convert?

Master Level II with our CFA Course

Related Questions

Practice Questions