You bought one of Great White Shark Repellant Cos 8 percent

You bought one of Great White Shark Repellant Co\'s 8 percent coupon bonds one year ago for $770. These bonds make annual payments and mature 7 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 9 percent. If the inflation rate was 3.6 percent over the past year, what was your total real return on investment? ? 19.05% ? 29.08% ? 38.54% ? 29.18% ? 30.53%

Solution

Step 1 – Compute the Nominal Rate of Return of the Bond

Calculate the Price of the Bond

= $80 x (PVIFA 9%, 7 Years) + $1,000 x (PVIF 9%, 7 Years)

= [$80 x 5.032952] + [$1,000 x 0.54703424]

= $402.64 + 547.03

= $949.67

Nominal Rate of Return

Nominal Rate of Return = [{($949.67- 770) + $80} / 770] x 100 = 33.72%

Step 2 – Real return on Investment

Real return on Investment = [{(1 + Nominal Rate) / (1 + Inflation Rate)} – 1] x 100

= [ (1.3372 / 1.036) – 1] x 100

= 0.2908 or

= 29.08%

“Therefore, Real return on Investment = 29.08%”