You bought one of Rocky Mountain Manufacturing Co.’s 8.75 percent coupon bonds o

Question

You bought one of Rocky Mountain Manufacturing Co.’s 8.75 percent coupon bonds one year ago for $1,051.80. These bonds make annual payments and mature eight years from now. Suppose that you decide to sell your bonds today, when the required return on the bonds is 8.25 percent.

If the inflation rate was 3.8 percent over the past year, what would be 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 on investment             %

Explanation / Answer

Holding period return:

= ($1,028.46+$87.50-$1,051.80)÷$1,051.80

= 6.10%

(1+Nominal rate) = (1+Real rate)×(1+Inflation rate)

(1+6.10%) = (1+Real rate)×(1+3.8%)

Real rate return = 2.22%

Face value (FV) $                                         1,000 Coupon rate 8.75% Number of compounding periods per year 1 Interest per period (PMT) $                                         87.50 Number of years to maturity 8 Number of compounding periods till maturity (NPER) 8 Market rate of return/Required rate of return 8.25% Market rate of return/Required rate of return per period (RATE) 8.25% Bond price PV(RATE,NPER,PMT,FV)*-1 Bond price $                                   1,028.46

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