Question

Malcom buys a 5% coupon bond that matures in 5 years at its par value of $1,500. The consumer price index increases by 5% over the corresponding period. What is the real value of the bond at maturity?

Answer 1

Explanation:

To determine the real value of the bond at maturity, we need to adjust for the increase in the consumer price index (CPI) over the corresponding period.

The CPI increase of 5% indicates that prices have risen by that percentage. Therefore, we can consider this as the inflation rate.

To calculate the real value of the bond, we divide the par value by the inflation-adjusted factor:

Real Value = Par Value / (1 + Inflation Rate)

Substituting the values into the formula:

Real Value = $1,500 / (1 + 0.05)

Calculating this expression gives us:

Real Value ≈ $1,500 / 1.05

≈ $1,428.57

Therefore, the real value of the bond at maturity, after adjusting for a 5% increase in the consumer price index, is approximately $1,428.57.

Hope this helps! :)