A bond that pays interest annually yields an 8.5% rate of return. The inﬂation rate for the same period is 4.6%. What is the actual real rate of return on this bond?

Question

Quizplus · Accepted Answer

The real rate of return can be calculated by subtracting the inflation rate from the bond's rate of return. Therefore, the real rate of return on this bond is 8.5% - 4.6%, which equals 3.9%. However, since the bond pays interest annually, we need to use the annual compound interest formula to calculate the actual real rate of return. This formula is (1 + real rate of return)^1 = 1 + (nominal rate of return - inflation rate)^1. Plugging in the numbers, we get (1 + real rate of return)^1 = 1 + (0.085 - 0.046)^1, which simplifies to (1 + real rate of return)^1 = 1.039. Solving for the real rate of return, we get 1 + real rate of return = 1.0373. Subtracting 1 from both sides, we get the real rate of return to be 0.0373, or 3.73%. Therefore, the best choice is B.

A Bond That Pays Interest Annually Yields an 8