Question

Assume you had the following investment in Exxon Bonds. You bought one of Exxon's 11 percent coupon bonds one year ago for $760. 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 14 percent. If the inflation rate was 3.2 percent over the past year, what was your total real return on investment?

Answer 1

Sol:

Par value (FV) = $1000

Coupon rate = 11%

PMT = Annual coupon rate = 1000 x 11% = $110

Period (nper) = 14 years

Required rate of return (r) = 14% p.a

Bonds price one year ago = $760

Inflation rate = 3.2%

We first have to determine present value (PV) of the bond, for determining holding period return and real rate of return.

Present value (PV) of the bond can be determined by using PV function in excel:

FV	1000
PMT	110
nper	14
Rate	14%
PV	819.94
Holding period return	22.36%
Real rate of return	18.57%

Therefore total real return on investment is 18.57%

Workings