Question

A bond par value is $1,000 and the coupon rate is 5.3 percent. The bond price was $946.16 at the beginning of the year and $980.41 at the end of the year. The inflation rate for the year was 2.7 percent. What was the bond's real return for the year?

Answer 1

6.35%

Step-by-step explanation:

Find the nominal rate of return of the bond in one year;

Original price = $946.16

Coupon payment = coupon rate *Face value = 5.3% *1000 = $53

New price = $980.41

Nominal rate of return =[(New price + Coupon payment - Original price) / Original price] *100

= [($980.41 + $53 - $946.16) /$946.16 ] *100

= (87.25/ 946.16)*100

= 0.0922*100

= 9.22%

Use Fisher equation to find the real return given an inflation rate of 2.7%;

(1 + Real) = (1+Nominal) / (1+ inflation)

1+Real = (1+0.0922) / (1 +0.027)

1+Real = 1.06349

Real = 1.06349 -1

Real = 0.06349 or 6.349%

Therefore, the real return is 6.35%