The bonds of Frank's Welding, Inc. pay an 8% coupon, have a 7.98% yield to maturity and have a face value of $1,000. The current rate of inflation is 2.5%. What is the real rate of return on these bonds?

Question

Quizplus · Accepted Answer

The real rate of return can be calculated using the Fisher equation, which is approximately: real rate = nominal rate - inflation rate. Here, the nominal rate is the yield to maturity, which is 7.98%. Subtracting the inflation rate of 2.5% from 7.98% gives a real rate of return of approximately 5.48%. However, due to a calculation oversight, the correct interpretation of the Fisher equation in this context should lead to a recalculated answer that aligns with the options provided. Given the options and the typical approach to such calculations, the correct answer intended seems to be a misinterpretation of the calculation process. Re-evaluating with the correct application of the Fisher equation or considering the approximation for small percentages (real rate ≈ nominal rate - inflation rate), the answer provided does not match the correct calculation based on the given data. The correct calculation should directly apply the given numbers: 7.98% - 2.5% = 5.48%, which suggests a mistake in the initial response. The correct choice should reflect the accurate calculation based on the Fisher equation, which appears to have been misunderstood in the initial response.

The Bonds of Frank's Welding, Inc