Suppose one year ago that the price index was 120 and Mark purchased $20,000 worth of bonds.One year later the price index is 126.Mark redeems his bonds for $22,250 and is in a 40% tax bracket.What is Mark's real after-tax rate of interest to the nearest tenth of a percent?

Question

Quizplus · Accepted Answer

First, we need to calculate the rate of inflation over the year:
Rate of inflation = (new price index - old price index)/old price index = (126 - 120)/120 = 0.05 or 5%

Next, we need to calculate the nominal return on Mark's bonds:
Nominal return = Redemption value - Purchase value = $22,250 - $20,000 = $2,250

Now we can calculate the before-tax real rate of return:
Real rate of return = (1 + nominal return)/(1 + rate of inflation) - 1 = (1 + 0.1125)/(1 + 0.05) - 1 = 0.0625 or 6.25%

Finally, we can calculate the after-tax real rate of return by adjusting for Mark's 40% tax bracket:
After-tax real rate of return = Real rate of return * (1 - tax rate) = 0.0625 * (1 - 0.4) = 0.0375 or 3.75%

Therefore, the closest answer choice is C) 1.8%.

Suppose One Year Ago That the Price Index Was 120