Question

You bought one of Shark Repellent 6 percent coupon bonds one year ago for $867. These bonds pay annual payments, have a face value of $1,000, and mature 12 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 7.4 percent. The inflation rate over the past year was 2.9 percent. What was your total real return on this investment

Answer 1

You bought one of Great White Shark Repellent Co.’s 7.4 percent coupon bonds one year ago for $1,041. These bonds make annual payments and mature 20 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 6 percent.  

If the inflation rate was 4 percent over the past year, what was your total real return on investment?

Bond Price = FV / (1 + i)^n + Pmt x (1 - 1 / (1 + i)^n) / i  

Bond Price = 1000 / (1 + 6%)^20 + 1000 x 7.4% x (1 - 1 / (1 + 6%)^20) / 6% = 1,160.58  

Return = (1160.58-1041)/1041 = 11.487% = i  

Real Rate = (i - g)/(1 + g) = (11.487%-4%)/(1+4%) = 7.199%