Final answer:
The rate of return on a bond before inflation adjustment is called the 1. nominal rate. It includes interest payments without considering the impact of inflation.
Step-by-step explanation:
The rate of return an investor earns on a bond prior to adjusting for inflation is called the nominal rate. The nominal rate considers the percentage that the investor will earn from the bond in terms of interest payments without taking into account the eroding effects of inflation on the purchasing power of the money received. Bonds vary in the rates of return they offer and an interest rate can typically be divided into three components: compensation for delaying consumption, an adjustment for an inflationary rise in the overall level of prices, which is called the real rate, and a risk premium that takes the borrower's riskiness into account.
For example, if an investor is receiving a nominal interest or coupon rate of 8% on a bond, and the annual inflation rate is 2%, then the real rate of return would be approximately 6% after adjusting for inflation. When interest rates rise, bonds previously issued at lower interest rates will sell for less than face value, while if interest rates fall, bonds issued at higher interest rates will sell for more than face value. The actual rate of return on a bond investment includes all earnings from the investment, such as capital gains and interest payments.