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?

Question

Quizplus · Accepted Answer

The real rate of return can be calculated using the formula: $$ \text{Real Rate of Return} = \frac{\text{Nominal Rate of Return} - \text{Inflation Rate}}{1 + \text{Inflation Rate}} $$ 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 $8.5\% - 2\% = 6.5\%$. Given an inflation rate of 3%, the real rate of return is: $$ \text{Real Rate of Return} = \frac{6.5\% - 3\%}{1 + 3\%} = \frac{3.5\%}{1.03} \approx 3.40\% $$

Curtis Bought an 8