Consider the following information for a period of years: 13 % 7.2 3.3 Long-term

Question

Consider the following information for a period of years: 13 % 7.2 3.3 Long-term corporate bonds Long-term govemment bonds Inflation What is the real return on long-term government bonds? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Real return What is the real return on long-term corporate bonds? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Real return

Explanation / Answer

Formula: Fisher Equation: (1 + Rnominal) = (1 + rreal) * (1 + iinflation) ...(1)

Rearranging (1) we get,

rreal = [(1 + Rnominal)/(1 + iinflation)] - 1 ...(2)

(a) Real Return on long-term government bonds:

given: Rnominal= 7.2%, iinflation=3.3%

Substituting in (2),

rreal = [(1 + Rnominal)/(1 + iinflation)] - 1

=  [(1 + 0.072)/(1 + 0.033)] - 1

= 0.037754 = 3.78% (rounded)

(b) Real Return on long-term corporate bonds:

given: Rnominal= 7.3%, iinflation=3.3%

Substituting in (2),

rreal = [(1 + Rnominal)/(1 + iinflation)] - 1

=  [(1 + 0.073)/(1 + 0.033)] - 1

= 0.038722 = 3.87% (rounded)

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