Asked by chisom chikezie on Jul 09, 2024
Verified
Curtis bought an 8.5% annual coupon bond at par. One year later, he sold the bond at a quoted price of 98. During the year, market interest rates rose and inflation was 3%. What real rate of return did Curtis earn on this investment?
A) 3.40%
B) 3.50%
C) 6.40%
D) 6.50%
E) 6.70%
Quoted Price
The most recent price at which a security, commodity, or asset was traded.
Real Rate
The interest rate that has been adjusted for inflation, reflecting the true return of an investment.
Annual Coupon
refers to the fixed interest payment that a bond issuer agrees to pay to the bondholder once every year until the bond's maturity date.
- Learn the procedures for computing and understanding real, nominal, and inflation rates of return.
- Analyze the effects of interest rates and inflation on bond prices and returns.
Verified Answer
KV
Kristian VolekJul 15, 2024
Final Answer :
A
Explanation :
The real rate of return can be calculated using the formula: Real Rate of Return=Nominal Rate of Return−Inflation Rate1+Inflation Rate \text{Real Rate of Return} = \frac{\text{Nominal Rate of Return} - \text{Inflation Rate}}{1 + \text{Inflation Rate}} Real Rate of Return=1+Inflation RateNominal Rate of Return−Inflation Rate Curtis bought the bond at par (100) and sold it at 98, which means he had a loss of 2% on the principal. However, he also received an 8.5% coupon payment. So, the nominal rate of return is 8.5%−2%=6.5%8.5\% - 2\% = 6.5\%8.5%−2%=6.5% . Given an inflation rate of 3%, the real rate of return is: Real Rate of Return=6.5%−3%1+3%=3.5%1.03≈3.40% \text{Real Rate of Return} = \frac{6.5\% - 3\%}{1 + 3\%} = \frac{3.5\%}{1.03} \approx 3.40\% Real Rate of Return=1+3%6.5%−3%=1.033.5%≈3.40%
Learning Objectives
- Learn the procedures for computing and understanding real, nominal, and inflation rates of return.
- Analyze the effects of interest rates and inflation on bond prices and returns.