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16 May, 20:17

A bond par value is $1,000 and the coupon rate is 5.3 percent. The bond price was $946.16 at the beginning of the year and $980.41 at the end of the year. The inflation rate for the year was 2.7 percent. What was the bond's real return for the year?

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  1. 16 May, 21:24
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    6.35%

    Explanation:

    Find the nominal rate of return of the bond in one year;

    Original price = $946.16

    Coupon payment = coupon rate * Face value = 5.3% * 1000 = $53

    New price = $980.41

    Nominal rate of return = [ (New price + Coupon payment - Original price) / Original price] * 100

    = [ ($980.41 + $53 - $946.16) / $946.16 ] * 100

    = (87.25 / 946.16) * 100

    = 0.0922*100

    = 9.22%

    Use Fisher equation to find the real return given an inflation rate of 2.7%;

    (1 + Real) = (1+Nominal) / (1 + inflation)

    1+Real = (1+0.0922) / (1 + 0.027)

    1+Real = 1.06349

    Real = 1.06349 - 1

    Real = 0.06349 or 6.349%

    Therefore, the real return is 6.35%
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