Question

You bought one of Great White Shark Repellant Co.'s 9 percent coupon bonds one year ago for $800. These bonds make annual payments and mature 12 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 12 percent. If the Inflation rate was 3.5 percent over the past year, what was your total real return on investment? Multiple Choice 16.98% 0 -167% 09.20% 9.66% 9.30%

Answer 1

Price of the bond 1 year ago = $800

Now,

Time to maturity = 12 years

Coupon 9% annually

So coupon = 9% of 1000 = $90

Face value = $1000

using financial calculator to calculate value of bond today with values

N = 12

I/Y = 12%

PMT = 90

FV = 1000

compute for PV, we get PV = $814.17

So total return over the year = capital gain + coupon,

So, nominal rate of return = (814.17 + 90 - 800)/800 = 13.02%

since inflation rate = 3.5%

Real rate of return = (1+ nominal)/(1 + inflation) - 1

So, real rate of return = 1.1302/1.035 - 1 = 9.20%