Answer:
a. Coupon payment = 8.5% of $1000 = $85
i = 9.5%
n = 9
m =$1,000
Price of the bond after one year P1 = C* [1- 1/ (1+i)^n] /i + M / (1+i)^n
P1 = $85 * [1 – 1 / (1+9.5%) ^9] /9.5% + 1000 / (1+9.5%) ^9
P1 = $499.40 + $441.85
P1 = $941.25
b. The rate of return on the bond = (Income from one coupon payment + capital appreciation)/ Initial price of the bond
The rate of return on the bond = [$85 + ($941.25 - $1,150)]/ $1,150
The rate of return on the bond = ($85 - $208.75)/ $1,150
The rate of return on the bond = - $123.75/ $1,150
The rate of return on the bond = - 0.1076
The rate of return on the bond = -10.76%
c. f the inflation rate during the year is 3%
Real rate of return = [(1+ Nominal rate of return)/ (1+ Inflation rate)]-1
Where Nominal rate of return = - 10.76%, Inflation rate = 3%
Real rate of return = [(1-10.76%)/ (1+ 3%)]-1
Real rate of return = 0.08664 -1
Real rate of return = - 0.1336
Real rate of return = -13.36%
