Suppose you bought a bond with an annual coupon of 7% one year ago for $1,010. The bond sells for $985 today. A. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year?B. What was your total nominal rate of return on this investment over the past year? C. If the inflation rate last year was 3%, what was your total real rate of return on this investment?

(a) $45

(b) 4.45%

(c) 1.4%

Explanation:

Mentioned that,

The Value of bond one year ago is $1,010

The Annual coupon rate is 7%

The Selling value of bond today is $985

The Face value is $1,000

Based on the above information, the calculations are shown below:

a. Total dollar return on this investment is

= Current bond price - previous year price + Coupon payment

= $985 - $1,010 + ($1,000 × 7%)

= $985 - $1,010 + $70

= $45

(b)  The total Nominal rate of return on this investment is

= [(Current bond price - previous year price + Coupon payment) ÷ previous year price]

=  [($985 - $1,010 + ($1,000 × 7%)) ÷ $1,010]

= $45 ÷ $1,010

= 0.0445

= 4.45%

(c) In case when Inflation rate last year is 3%

The Total real rate of return is

= [(1 + Nominal rate) ÷ (1 + Inflation rate)] - 1

= [(1 + 4.45%) ÷ (1 + 3%)] - 1

= 1.0140 - 1

= 0.0140

= 1.4%

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