Suppose a bond with a three-year maturity, par value of $1 000, and a coupon rate of 4%. We assume the bond makes annual coupon payments, and inflation turns out to be 2%, 3%, and 1% in the next three years. 

 

What is the nominal return and real return on this bond?

 

Transcribed Image Text:

Time 0 1 2 3 Inflation in Year Just Ended 2% 3 1 Par Value $1,000.00 1,020.00 1,050.60 1,061.11 Coupon Payment + Principal Repayment $40.80 42.02 42.44 0 0 $1,061.11 = Total Payment $ 40.80 42.02 1,103.55 Time 0 1 2 3 Inflation in Year Just Ended 2% 3 1 Par Value $1,000.00 1,020.00 1,050.60 1,061.11 Coupon Payment + Principal Repayment $40.80 42.02 42.44 0 0 $1,061.11 = Total Payment $ 40.80 42.02 1,103.55

Answer rating: 100% (QA)

We must account for coupon payments principal repayment and the impact of inflation when calculating ... View the full answer