Question

Suppose you bought a bond with a coupon rate of 4.2 percent paid annually one year ago for $900. The bond sells for $950 today.

a.	Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

Total dollar return

$

b.	What was your total nominal rate of return on this investment over the past year? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Nominal rate of return

%

c.	If the inflation rate last year was 2.5 percent, what was your total real rate of return on this investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Real rate of return

%

Answer 1

Answer

(a) Total $ Return = (Coupon Payment Received for 1year) + (Capital Appreciation during 1year)

= ($1000 * 4.2%) + ( Sale Price - Purchase Price)

= ($ 42) + ($950 - $900)

= ($ 42) + ( $50)

$ 92

(b) Nominal Rate of Return is the Rate which show what did we earned over the year without taking effect of Inflation.

Nominal Rate of Return = { Total Return on Investment / Total Cost } * 100

= { $92 / $900) * 100

= 10.22% approx

(c) Real Rate of Return on the other hand shows that though we earned 10.22% but Inflation has also rosed over the year and hence have reduced the value of money. So Real Rate takes into account the Inflation Rate & tells us What is our Actual Rate of Return.

Real Rate of Return = Nominal Rate of Return (-) Inflation Rate

= 10.22% (-) 2.5%

=7.72% approx

HOPE YOU ARE CLEAR NOW. STILL IF ANY DOUBT PLEASE ASK IN COMMENT :)