Question

The bonds of Frank's Welding, Inc. pay an 8% coupon, have a 7.98% yield to maturity and have a face value of $1,000. The current rate of inflation is 2.5%. What is the real rate of return on these bonds?

a. 5.32%
b. 5.35%
c. 5.37%
d. 5.42%
e. 5.48%

Answer 1

Answer:

c. 5.37%

Explanation:

As Coupon rate is Nominal Interest rate and Yield to maturity is effective interest rate.

Nominal Interst rate = Coupon Rate = 8% = 0.08

Inflation Rate = 2.5% = 0.025

1 + real Rate of return  = $\frac{1 + Nominal Interest rate}{1 + Inflation rate}$

Real Rate of return  = $\frac{1 + Nominal Interest rate}{1 + Inflation rate}$ - 1

Real Rate of return  = $\frac{1 + 0.08}{1 + 0.025}$ - 1

Real Rate of return  = 5.37%

So, the real rate of return on these bonds is 5.37%.