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10-19I

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Essentials Of Investments
Found in: Page 330
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

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Short Answer

Return to Table 10.1 and calculate both the real and nominal rates of return on the TIPS bond in the second and third years.

Time

Inflation in Year just ended

Par Value

Coupon Payment

Coupon Payment + Principal payment

Total Payment

0

$ 1000 .00

1

2

$ 1020.00

$ 40.80

0

$ 40.80

2

3

$ 1050. 60

$ 42.02

0

$ 42.02

3

1

$ 1061.11

$ 42.44

$ 1061.11

1103.54

Second year = 7.12% and 4.00%

Third year = 5.04% and 4.00 %

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Step by Step Solution

Calculation of Nominal return and real return in the second year

The formulae for Nominal Return = Interest + Price Appreciation / Initial Price

= $ 42.20 + $ 30.60 / $ 1020.00

= 0.071196

= 7.12%

The formula for real return = 1 + Nominal return / 1 + Inflation rate – 1

= (1 + 0.071196) / (1 + 0.03) – 1

= 1.071196 / 1. 03 – 1

= 1.0400 – 1

= 4.00 %

Calculation of Nominal return and real return in the third year

The formulae for Nominal Return = Interest + Price Appreciation / Initial Price

= $ 42.44 + $ 10.51 / $ 1050.60

= 0.050400

= 5.04%

The formula for real return = 1 + Nominal return / 1 + Inflation rate – 1

= (1 + 0.050400) / (1 + 0.01) – 1

= 1.050400 / 1. 01 – 1

= 1.0400 – 1

= 4.00 %

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