Sapna would like to receive a real return of 5 percent per year on a bond investment at a time when the expected inflation rate is 2.5 percent. How much would she be willing to pay for a bond maturing in two years if it pays annual coupons at a (nominal) rate of 7 percent? If a Real Return Bond were available with a 4.5-percent coupon (annual payments) and the same two-year maturity, how much would Sapna be willing to pay for it to achieve her desired rate of return?
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