Answer question 2SolutionQUESTION 2 The real return 7 and t

Answer question 2.

QUESTION 2

The real return = 7% and the inflation = 4%

We now have to calculate the nominal return with these two data.

real return = (nominal - inflation)/(1+inflation)

0.07 = (nominal -0.04)/1.04

Nominal = 0.07*1.04 +0.04 =0.1128

Nominal interest rate = 11.28%

Stock: Since there is a 2% dividend, the annual return required after dividend = 11.28%-2% = 9.28%

So, selling price of stock should be (after 5 years, we have power of 5) = 50,000*1.0928^5 = $77,924 (Rounded)

Bond: Bond gives a 5% coupon simialr to a dividend, So the required return after coupons = 11.28%-5% = 6.28%

So, selling price of Bond should be (after 5 years) = 50,000*1.0628^5 = 67,799.69 = 67,800