Suppose that you buy a two-year 7.2% bond at its face value. a-1. What will be y

Question

Suppose that you buy a two-year 7.2% bond at its face value. a-1. What will be your total nominal return over the two years if inflation is 2.2% in the first year and 4.2% in the second? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Nominal return a-2. What will be your real return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Real return b. Now suppose that the bond is a TIPS. What will be your total 2-year real and nominal returns? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) Real return Nominal return

Explanation / Answer

Bond a.Your nominal return will be 1.072^2 - 1 = 14.92% over the two years Your Real return is (1.072 / 1.022) x ( 1.072 / 1.042) - 1 = 7.91% b.With the TIPS , the real return will remain at 7.2% per year,or 14.92% over two years.The nominal return on the TIPS will equal (1.072 x 1.022) x (1.072 x 1.042) - 1 = 22.38%

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