Question

You bought one of Great White Shark Repellant Co.’s 9 percent coupon bonds one year ago for $800. These bonds make annual payments and mature 10 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 11 percent. If the inflation rate was 3 percent over the past year, what was your total real return on investment?

Answer 1

Price of the bond = Present value of the annual coupon and face value discounted at required return

Annual Coupon = 9%*1000 = 90

Face Value = 1000

Number of payments = 10

Price = 90/(1+0.11)^1 + 90/(1+0.11)^2 +90/(1+0.11)^3 +90/(1+0.11)^4 +90/(1+0.11)^5 +90/(1+0.11)^6 +90/(1+0.11)^7 + ............ 90/(1+0.11)^10 + 1000/(1+0.11)^10

Price = 882.22

Total Return = ((882.22 + 90 - 800) /800 ) *100 = 21.53%

Total Real Return = [ (1+total return) / (1 + inflation) ] - 1 = [ (1+0.2153) / (1 + 0.03) ] - 1 = 17.99% Answer