1. An investment offers a 13 percent total return over the coming year. Jim Kelly thinks the total real return on this investment will be only 7 percent. What does Jim believe the inflation rate will be over the next year?
Interpreting Bond Yields
Suppose you buy a 7 percent coupon, 20 year bond today when it's first issued. If interest rates suddenly rise to 15 percent, what happens to the value of your bond? Why?
1. Jim believes the inflation will be 6%. If inflation is at 6%, it means that prices are rising at a rate of 6% so your dollar is losing value unless investment returns are greater than 6%. So the first 6% of returns on this bond is ...
This solution describes, with examples, the effects of the return on a bond when taking interest rates and inflation into consideration.