Suppose you bought a $1,000 face value bond with a coupon rate of 5.6 percent one year ago. The purchase price was $987.50. You sold the bond today for $994.20. If the inflation rate last year was 2.6 percent, what was your exact real rate of return on this investment?

Question

Quizplus · Accepted Answer

The real rate of return can be calculated using the formula for the exact real return, which is (1 + nominal return) / (1 + inflation rate) - 1. First, calculate the nominal return: you received $56 (5.6% of $1000) in coupon payments and had a capital gain of $6.70 ($994.20 - $987.50). So, the total return is $62.70. The nominal return is $62.70 / $987.50 = 0.0635 or 6.35%. Using the inflation rate of 2.6% or 0.026, the exact real return is (1 + 0.0635) / (1 + 0.026) - 1 = 1.0635 / 1.026 - 1 ≈ 0.0365 or 3.65%.

Suppose You Bought a $1,000 Face Value Bond with a Coupon