Question

You bought one of Great White Shark Repellant Co.'s 8 percent coupon bonds one year ago for $810. These bonds make annual payments and mature 14 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 11 percent. If the inflation rate was 3.4 percent over the past year, what was your total real return on investment?

Answer 1

real rate of return = 4.77%

Step-by-step explanation:

you purchased the bond at $810 with 14 years to maturity

now, 1 year later the bond's price is:

• PV of coupon payment = $1,000 / 1.11¹³ = $257.51
• PV of coupon payments = $80 x 6.7499 (PV annuity factor, 11%, 13 periods) = $539.99

market value = $797.50

total nominal returns = $80 (coupon payment) + ($797.50 - $810) = $67.50

the real rate of return = {[1 + ($67.50/$810)] / (1 + 3.4%)} - 1 = 4.77%