Question

Refer to the table below and calculate both the real and nominal rates of return on the TIPS bond in the second and third years. (Do not round intermedlate calculations. Round your answers to 2 decimal places.) Principal and Interest Payments for a Treasury Inflation Protected Security Inflation in Year Coupon Principal Time Just Ended Par Value Payment + Repayment = Total Payment $1,000.00 1,020.00 $51.00 ,050.60 1,061.11 $ 51.00 52.53 1,114.16 2% 52.53 53.06 2 $1,061.11 Second Year Third Year Nominal return Real return

Answer 1

	Second year	Third year
Nominal return	8.15%	6.05%
Real return	5%	5%

Second Year:

The rate of return on a bond is:

Nominal Return = Interest + Price change / Initial price

Nominal Return = 52.53 + 1050.60-1020 / 1020

= 8.15 %

The real rate of return can be found like this:

Real rate = (1+ Nominal rate)/(1+ Inflation ) – 1

Real rate = (1+0.0815)/(1+0.03 ) – 1

Real rate = 5%

Third Year

Using the same approach:

The rate of return on a bond is:

Nominal Return = Interest + Price change / Initial price

Nominal Return = 53.06 + 1061.11- 1050.60 / 1050.60

= 6.05 %

The real rate of return can be found like this:

Real rate = (1+ Nominal rate)/(1+ Inflation ) – 1

Real rate = (1+0.0605)/(1+0.01 ) – 1

Real rate = 5%