Question

Question #8 (20 Points): If you buy municipal bond (tax free) that cost $1,000 and will pay a 4.5% coupon for the next 20 years (so the maturity date is in 20 years). At maturity the bond returns the original $1,000. If there is a 2% annual inflation, what real rate of return will you receive?

Answer 1

Solution :-

Coupon Payment every Year = $1,000 * 4.5% = $45

In case the bond purchase price is same has maturity price then the annual coupon rate is the return

Therefore here nominal rate of return = 4.5%

Now if Rate of Inflation = 2%

Then Real Rate of Return = [ ( 1 + 0.045 ) / ( 1 + 0.02 ) ] - 1 = 0.0245 = 2.45%

Proof of Nominal Return

H13 А в с 2 Solution - (22) Year Cash Flows ($1,000) $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $45 $1,045 13 19 20 28 IRR = 4.50% 29 IRR(B5:B26) 30 Formula 31

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