Question

Bond A is a 6 % coupon bond with annual payment and 1 year to maturity. The bond face value is 1,000 and the bond is currently selling at $980.70. Investors expect the inflation rate to be 3% during the year, but at the end of the year, the inflation rate turned out to be 2%.

What is the nominal interest rate on this bond? Calculate the nominal interest rate

What is the expected real interest rate on this bond?

What is the real interest rate on this bond?

Is the YTM the same thing as coupon rate?

Answer 1

(1)

Nominal interest rate = (Face value / Current Price) - 1 = ($1,000 / $980.70) - 1 = 1.0197 - 1 = 0.0197 = 1.97%

(2)

Expected real interest rate = Nominal interest rate - Expected inflation rate = 1.97% - 3% = - 1.03%

(3)

Actual real interest rate = Nominal interest rate - Actual inflation rate = 1.97% - 2% = - 0.03%

(4)

YTM is different from coupon rate. While coupon rate states the fixed percent of face value that investors will get as periodic coupon (interest) income from the bond, YTM measures the actual yield (return) received when the investor holds the bond till maturity.