You bought one of Shark Repellant's 6 percent coupon bonds one year ago for $867. These bonds pay annual payments, have a face value of $1,000, and mature 12 years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 7.4 percent. The inflation rate over the past year was 2.9 percent. What was your total real return on this investment?

Question

Quizplus · Accepted Answer

First, we need to calculate the coupon payment: 
Coupon payment = Face value x Coupon rate = $1,000 x 6% = $60

Next, we need to calculate the selling price of the bond today: 
PV = Coupon payment x (1 - (1 + r)^-n) / r + Face value / (1 + r)^n 
PV = $60 x (1 - (1 + 0.074)^-12) / 0.074 + $1,000 / (1 + 0.074)^12 
PV = $907.24

The total real return is the nominal return minus the inflation rate: 
Total real return = (Selling price + Coupon payment received) / Initial investment - 1 - Inflation rate 
Total real return = ($907.24 + $60) / $867 - 1 - 0.029 
Total real return = 0.0661 or 6.61%

Therefore, the answer is B.

You Bought One of Shark Repellant's 6 Percent Coupon Bonds