Question

Suppose that you buy a TIPS (inflation-indexed) bond with a 1-year maturity and a coupon of 7% paid annually. Assume you buy the bond at its face value of $1,000, and the inflation rate is 8%.

(a) What will be your cash flow at the end of the year?
(b) What will be your real return?
(c) What will be your nominal return?

Answer 1

Answer:

at maturity I will receive 1,155.6

the real return is 7%

the nominal will be 15.56%

Explanation:

As it is indexed it will paid a real rate of 7% adjusted for 8% inflation

$1,000(1+r)(1+\delta)=Amount$

1,000 x 1.07 x 1.08 = 1,155.6 received at maturity

no know the nominal rate we do:

$\frac{Amount}{Principal}-1$

$\frac{1,155.6}{1,000}-1$

nominal = 0.1556 = 15.56%