You bought one of Great White Shark Repellant Co.'s 5.6 percent coupon bonds one year ago for $1,051. These bonds make annual payments and mature 10 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 4.5 percent.

If the inflation rate was 4.2 percent over the past year, what was your total real return on investment?

First, compute the Yield to maturity (YTM);

N = 11

PV = - 1,051

FV = 1,000

PMT = 0.056*1000 = 56

then CPT I/Y = 4.99%

Next, compute the price of the stock today;

N = 10

PMT = 56

FV = 1,000

I/Y = 4.99%

then CPT PV = 1,047.13

Return = [ (P1 + Income - P0) / P0] * 100

Return = [ (1,047.13 + 56 - 1,051) / 1,051) ]*100

= (52.13/1051) * 100

= 0.0496 * 100

=4.96%

If inflation rate was 4.2%, then real return = 4.96% - 4.2%

Real return = 0.76%