You bought one of Bergen Manufacturing Co.’s 7.8 percent coupon bonds one year a

Question

You bought one of Bergen Manufacturing Co.’s 7.8 percent coupon bonds one year ago for $1,061. These bonds make annual payments and mature twelve years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 4.5 percent.

If the inflation rate was 4.4 percent over the past year, what would be your total real return on the investment? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

FYI- the answer is NOT 23.76%,25.61%, 17.44%, or $271.23

You bought one of Bergen Manufacturing Co.’s 7.8 percent coupon bonds one year ago for $1,061. These bonds make annual payments and mature twelve years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 4.5 percent.

Explanation / Answer

The present Value of the bond is PV(0.045,12,78,1000) =1300.91

where rate = 0.045, number of periods=nper-12, coupon payment =pmt = 78 and face value =fv=1000

Now total profit = 1300.91 -1061 = 239.91. We have to include a coupon payment of 78 during the year the bondholder received.

So total ptofit is 239.91 + 78 = 317.91

So return is 317.91/1061 = 29.96%

Now the real rate of return accrding to fischers formula is (nr-ir)/(1+ir) *100 wher nr = nominal rate and ir = inflation rate.

here nr=29.96% and ir =4.4%. Substituting in the formula, the real rate of return would be 24.48%

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