Question

You bought one of Colton Manufacturing Co.’s 5.4 percent coupon bonds one year ago for $1,053. These bonds make annual payments and mature twelve years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 4.5 percent. The par value is $1,000. If the inflation rate was 3.8 percent over the past year, what would be your total real return on the investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

- Bond price one year ago(P0) = $1053

Par Value of Bond = $1000

Annual coupon payment =$1000*5.4% = $54

No of years from maturity from today = 12

Required rate of return (YTM) = 4.5%

Calculating the Price of Bond today:-

Price = $492.40 + $589.66

Price = $ 1082.06

So, Price of Bond today(P1) = $ 1082.06

Calculating the Total Rate of return of ond over 1 years:-

Total Rate of return = [(P1 - P0)+ Coupon Payment]/P0

=[($1082.06 - $1053) + $54]/$1053

= 7.8879%

So, Total rate of return = 7.8879%

Inflation rate = 3.8%

Calculating total real return on the investment:-

Real rate of Return = [(1+Total rate of return)/(1+Inflation rate)] - 1

={(1+0.078879)/(1+0.038)] - 1

= 3.94%

So, total real return on the investment is 3.94%

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