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%