Assume one investor bought a 10-year inflation-protected bond with a fixed annual real rate of 1.5% and another investor bought a 10-year bond without inflation protection with a nominal annual return of 4.2%. If inflation over the 10-year period averaged 3 percent, which investor earned a higher real return?
A) The investor who purchased the inflation protected bond.
B) The investor who purchased the bond without inflation protection.
C) Both investors earned the same real return.
D) Neither investor earned a positive real return.

Question

Quizplus · Accepted Answer

The investor who purchased the inflation-protected bond earned a higher real return. This is because the inflation-protected bond is designed to protect against inflation, so the actual return earned is the fixed real rate plus the inflation rate. In this case, the real return for the inflation-protected bond would be 1.5% + 3% = 4.5%. On the other hand, the nominal return of the bond without inflation protection is 4.2%, but the real return after subtracting inflation would be only 1.2% (4.2% - 3%). Therefore, the investor who purchased the inflation-protected bond earned a higher real return.

Assume One Investor Bought a 10-Year Inflation-Protected Bond with a Fixed