bought a bond for $10,000. received interest of $400 at end of year, as well as $10,000 principal. inflation rate last year is 5%, calculate the real return. show work
To calculate the real return on your bond investment, we need to consider the impact of inflation on your investment returns.
Step 1: Calculate the nominal return:
Nominal return = Interest received + Principal received
Nominal return = $400 + $10,000
Nominal return = $10,400
Step 2: Calculate the inflation-adjusted (real) return:
Real return = Nominal return - (Nominal return × Inflation rate)
Real return = $10,400 - ($10,400 × 0.05)
Real return = $10,400 - $520
Real return = $9,880
Therefore, the real return on your bond investment after adjusting for inflation is $9,880.
Explanation:
The nominal return represents the total return on your investment without considering the impact of inflation. This includes the interest received ($400) and the principal received ($10,000).
The real return accounts for the effects of inflation. We calculate it by subtracting the amount that inflation eroded from the nominal return. In this case, the inflation rate of 5% is applied to the nominal return of $10,400. This represents the amount of money that would have been lost due to the eroding effect of inflation.
By subtracting the inflation-adjusted amount from the nominal return, we find the real return on your investment after accounting for inflation, which in this case is $9,880.