Question

Jack bought a five-year 4.25% annual coupon bond for $974 a year ago.

Today, he sold the bond at the market yield of 4%.

What is Jack's approximate real rate of return if the inflation rate over the past year was 2.2%?

a) 1.80%

b) 2.05%

c) 5.76%

d) 5.98%

Answer 1

P0 = $974

Bond price today, P1

FV = 1,000

cpn = 1,000 * 0.0425 = 42.5

r = 4%

n = 4

Nominal return = (P1 + cpn)/P0 - 1

Nominal return = (1,009.0747380922 + 42.5)/974 - 1

Nominal return = 1.0796455217 - 1

Nominal return = 0.0796455217

Nominal return = 7.96455217%

Real return = Nominal return - Rate of inflation

Real return = 7.96455217% - 2.2%

Real return = 5.76455217%

Real return = 5.76%

Option c) is correct