Question

Suppose that you buy a 1-year maturity bond with a coupon of
9.0% paid annually. If you buy the bond at its face value, what
real rate of return will you earn if the inflation rate is 2%? 4%?
11.00%? **(Do not round intermediate calculations. Enter your
answers as a percent rounded to 2 decimal places. Negative amount
should be indicated by a minus sign.)**

Real Rate of Return | |
---|---|

2% | |

4% | |

11.00% |

Answer #1

If the bond is bought at par, this means

Coupon Rate = Yield = 9%

a). **If Inflation = 2%**

Real Rate = [(1 + Nominal Rate) / (1 + Inflation Rate)] - 1

= [1.09/1.02] - 1 = 1.0686 - 1 = 0.0686, or 6.86%

a). **If Inflation = 4%**

Real Rate = [(1 + Nominal Rate) / (1 + Inflation Rate)] - 1

= [1.09/1.04] - 1 = 1.0481 - 1 = 0.0481, or 4.81%

a). **If Inflation = 11%**

Real Rate = [(1 + Nominal Rate) / (1 + Inflation Rate)] - 1

= [1.09/1.11] - 1 = 0.9820 - 1 = -0.0180, or 1.80%

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Please Explain Answer

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