Question

You bought one of Great White Shark Repellant Co.’s 10 percent coupon bonds one year ago for $810. These bonds make annual payments and mature 15 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 14 percent. If the inflation rate was 3.3 percent over the past year, what was your total real return on investment?

Multiple Choice

• 2.21%

• 2.10%

• -9.85%

• 2.20%

• 8.95%

Answer 1

We would calculate the price of bond today when required return is 14%
Price of bond is equal to present value of coupon payment plus present value of face value
Coupon amount = 1000*10%		100
Calculation of price of bond is shown below
Year	Cash flow	Discount factor @ 14%	Present Value
1	100	0.87719	$87.72
2	100	0.76947	$76.95
3	100	0.67497	$67.50
4	100	0.59208	$59.21
5	100	0.51937	$51.94
6	100	0.45559	$45.56
7	100	0.39964	$39.96
8	100	0.35056	$35.06
9	100	0.30751	$30.75
10	100	0.26974	$26.97
11	100	0.23662	$23.66
12	100	0.20756	$20.76
13	100	0.18207	$18.21
14	100	0.15971	$15.97
15	1100	0.14010	$154.11
		Price of bond	$754.31
Return on bond = (Sale price - Purchase price + Coupon amount)/Purchase price
Return on bond	(754.31-810+100)/810
Return on bond	5.47%
The return calculated is nominal return without considering the inflation impact.
Formula to calculate real return
Real return = (1+Nominal return)/(1+inflation return) - 1
Real return	(1.0547)/(1.033) - 1
Real return	2.10%
The total real return on investment is 2.10%