Suppose you bought a 7 percent coupon bond one year ago for $810. The bond sells

Question

Suppose you bought a 7 percent coupon bond one year ago for $810. The bond sells for $875 today. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year? What was your total nominal rate of return on this investment over the past year? If the inflation rate last year was 4 percent, what was your total real rate of return on this investment? (Do not round intermediate calculations.) Six months ago, You purchased 2, 200 shares of ABC Stock for $27.49 share. You have received dividend payments equal to $0.70 a share. Today, You sold all of your shares for $29.48 a share. What is your total doller return on this investment? One year ago. you purchased a stock at a price of $33.49. The stock pays quarterly dividends of $0.20 per share. Today, the stock is selling for $28.20 per share. What is your capital gain on this investment?

Explanation / Answer

1).

Requirement 1:

Dollar return would comprise of capital gain resulting from increase in bond prices and interest payment received during the year. The formula for calculating dollar return is:

Dollar Return on Bonds = Capital Gain + Interest Payments

Capital Gain = Bond Price at Year End - Bond Price at Beginning

Interest Payment = Face Value*Coupon Rate

Face Value = $1,000

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Solution:

Using the values provided in the question, we get,

Capital Gain = $875 - $810 = $65

Interest Payment = $1,000*7% = $70

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Dollar Return on Bonds = $65 + $70 = $135

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Requirement 2:

We can use EXCEL/Financial calculator to determine the nominal rate of return on the bonds. The formula/function for calculating nominal return is Rate(Nper,PMT,-PV,FV) where Rate = Rate of Return, Nper = Period, PMT = Interest Payment, PV = Purchase Value of Bond and FV = Future Value of Bond.

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Solution:

Here, Rate = ?, Nper = 1, PMT = 1,000*7% = 70, PV = $810, and FV = $875

Using these values in the above formula/function, we get,

Nominal Rate of Return = Rate(1,70,-810,875) = 16.67%

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Requirement 3:

Real rate of return is the nominal rate of return adjusted for inflation. The formula for calculating real rate of return is:

Real Rate of Return = (1+Nominal Rate of Return)/(1+Inflation) - 1

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Solution:

Using the nominal rate of return calculated in step 2 and inflation rate provided in the question, we get,

Real Rate of Return = (1+16.67%)/(1+4%) -1 = 12.18%

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2.

Dollar return would comprise of capital gain resulting from increase in share prices and dividend received during the year. The formula for calculating dollar return is:

Dollar Return on Stocks = Total Shares*(Capital Gain Per Share + Dividend Per Share)

Capital Gain = Stock Price at Sale - Purchase Price

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Solution:

Using the values provided in the question, we get,

Capital Gain = $29.48 - $27.49 = $1.99

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Dollar Return on Stock = 2,200*(1.99 + .70) = $5,918 (which is Option E)

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3.

Capital gain results from change in price of stock over a period of time. If the current price of the stock is more than the purchase price, it results in a capital gain and vice versa. The formula for calculating capital gain is:

Capital Gain = Current Stock Price - Purchase Price

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Solution:

Using the values provided in the question, we get,

Capital Gain/Loss = $28.20 - $33.49 = -$5.29 (which is Option C)

Since, the current stock price is less than the purchase price, it is resulting in a capital loss.

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