What real return rate is earned by a one year investor in a $1000 bond purchase,8% coupon rate & $960 selling?

price when the inflation rate was 6%?

A.-1.89%
B. 1.92%
C. 5.66%
D. 11.47%

Since you have a 8% coupon rate, you are getting an 8% annual rate of return from the bond value.

You paid $1000 for the bond. Got $80 in interest ($1000 * .08)after that one year. Sold the bond for $960.

So after one year, you have $1040. (-$1000 bond payment + $80 interest + $960 selling)

But there was a 6% rate of inflation. So you would need $1060 today to be equivalent to $1000 last year in terms of real dollars--today's dollars are each worth less than last year's dollars because of inflation.

So you actually LOST $20 in terms of real dollars.

To get to your rate of return:

($1040 actual money-$1060 value of initial investment plus inflation)/$1060 value of initial investment plus inflation = -$20/$1060 = -0.0189 = -1.89%

So the answer is A.

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