Question

Suppose you bought a bond with an annual coupon rate of 10% percent one year ago for $1,500. The bond sells for $1,650 today. Assuming a $1,000 face value:

a) What was your total dollar return on this investment over the past year?

b) What was your total nominal rate of return on this investment over the past year?

c) If the inflation rate last year was 5 %, what was your total real rate of return on this investment?

d) Why does inflation reduce the rate of return on an investment?

Answer 1

a) What was your total dollar return on this investment over the past year?

Answer :

total dollar return = Interest payment + Capital gain

total dollar return = (1000 * 10%) + (1650 -1500)

total dollar return = 250

b) What was your total nominal rate of return on this investment over the past year?

Answer :

Nominal rate = total dollar return / Initial investment

Rate of return = 250 / 1500

Rate of return = 16.67%

c) If the inflation rate last year was 5 %, what was your total real rate of return on this investment?

Answer :

Real rate of return = Nominal rate of return - Inflation rate

Real rate of return = 16.67% - 5%

Real rate of return = 11.67%

d) Why does inflation reduce the rate of return on an investment?

Inflation reduces the value of investment returns over time, If investor earns nominal rate higher than inflation then they are earning positive real returns that means they ca