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You bought one of Great White Shark Repellant Co's 8
You bought one of Great White Shark Repellant Co's 8.6 percent coupon bonds one year ago for $1,046. These bonds make annual payments and mature 15 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 8 percent. The bonds have a par value of $1,000 If the inflation rate was 3 percent over the past year, what was your total real return on investment? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Total real return
Expert Solution
~ Value of Bond today (Selling price) :
FV = $1,000
N = 15
PMT = $1,000 x 8.6% = $86
I/Y = 8%
Inputting these values in the financial calculator, and computing for "PV", press "CPT" "PV", we get =
PV = 1,051.36
Therefore, the bond is sold today at $1,051.36
~ Total Return on Bonds Investment:
~ The bond was bought one year ago and sold today, therefore only one annual coupon payment of $86 was earned.
~ Total return on bonds in one year:
= [Coupon + (Selling Price - Buy Price)] / Buy Price
= [$86 + ($1,051.36 - $1,046)] / $1,046
= 0.0873
Total Return in one year = 8.73%
~ Real Return :
(1 + Total Return) = (1 + Real Return) x (1 + Inflation)
Therefore,
Real Return = [(1 + Total Return) / (1 + Inflation)] - 1
= [1.0873 / 1.03] - 1
= 1.05563 - 1
= 0.05563
= 5.56%
Therefore, Total Real Return = 5.56%
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