Suppose that you purchase a $5,000 bond that pays 7 percent interest annually and matures in five years. If you expect that the inflation rate during the next five years will be 2 percent annually, what real rate of return do you expect to earn?
A) 2 percent
B) 5 percent
C) 7 percent
D) 9 percent

Question

Quizplus · Accepted Answer

To find the real rate of return, we need to adjust the nominal rate of return (7%) for inflation (2%). The formula for real rate of return is (1 + nominal rate)/(1 + inflation rate) -1. Plugging in the numbers, we get (1.07)/(1.02) -1 = 0.049 or 4.9%. Therefore, the real rate of return is 4.9%, which is closest to option B) 5%.

Suppose That You Purchase a $5,000 Bond That Pays 7