Question

You just learned that a blue chip company will issue a bond with a maturity of 100 years. The bond appears to be a good deal because it yields 5.78 percent. Assuming that the inflation rate stays at 4.39 ​percent, what is the​ bond's real rate of return​ today? If you are looking for a bond to purchase and hold for several​ years, will you buy this​ bond? Explain your answer in terms of future inflation projections and the length of the​ bond's maturity.

Answer 1

The bon's real rate of return is 1.39%.

As we know the inflation rate behave same as the bond yield because the bond yield includes the inflation impact.

In case of if there is a increase in the inflation in future. I will not buy this bond, because the price of the bond will fall and as percentage increases the present value of the cash flows also decreases which is the basis used for pricing the bons.

In case of if there is a decrease in the inflation in future, I will buy this bond, because the price of the bond will rise and as percentage decreases the present value of the cash flows also increases which is the basis used for pricing the bons.

Step-by-step explanation:

Real Rate of return = Nominal rate - Inflation rate

As Bond yield is nominal rate

Real rate of return = 5.78% - 4.39% = 1.39%