Suppose you bought a 8 percent coupon bond one year ago for $880. The bond sells

Question

Suppose you bought a 8 percent coupon bond one year ago for $880. The bond sells for $910 today. a. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? Total dollar return $ b. What was your total nominal rate of return on this investment over the past year? (Round your answer to 2 decimal places. (e.g., 32.16)) Nominal rate of return % c. If the inflation rate last year was 3 percent, what was your total real rate of return on this investment? (Round your answer to 2 decimal places. (e.g., 32.16)) Real rate of return %

Explanation / Answer

a. Face value = $1,000

Interest received = $1,000 x 8% = $80

Capital appreciation = $910 - $880 = $30

Total return in dollars = $80 +$30 = $110

b. Total nominal rate of return

= Total return/total investment

= $110/$880

=12.50%

C. Real rate of return

Method -1 A quick approximation

= Nominal rate - inflation rate

=12.5% - 3%

=9.50%

Method 2 - Using the formula

The precice value can be arrived using the formula,

(1+Nominal rate of return) = (1+Real rate of return) x (1+Inflation rate)

i.e, (1.125) = (1+R)x1.03

i.e, (1+R) = 1.09223

Real rate of return, R = 9.22 %

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