A bond that pays interest annually yields a rate of return of 5.75 percent. The inflation rate for the same period is 3 percent. What is the real rate of return on this bond? a. \( 8.75 \% \) b. \( 3.00 \% \) c. \( 2.67 \% \) d. \( 1.92 \% \) e. \( 1.03 \% \)

To calculate the real rate of return, you can use the Fisher equation, which states that the real interest rate is approximately the nominal interest rate minus the inflation rate. So, we have: Real Rate ≈ Nominal Rate - Inflation Rate Real Rate ≈ 5.75% - 3% = 2.75% Now, since the options provided don't match directly, we can also refer to the more precise formula: \((1 + nominal\ rate) = (1 + real\ rate) \times (1 + inflation\ rate)\). Using this formula: 1.0575 = (1 + real rate) * 1.03 Solving this gives us a real rate of about 2.67%. Therefore, the answer is: c. \( 2.67 \% \) --- Bonds have a rich history, with the first known issuance dating back to ancient Mesopotamia around 2400 B.C. As civilizations progressed, governments began to issue bonds as a means to finance wars and large projects. Fast forward to today, bonds are staples in investment portfolios, appealing to those seeking stable returns—often seen as the "safer" investment compared to stocks. When it comes to investing in bonds, it's crucial to remember that interest rates and bond prices move in opposite directions; as rates go up, bond prices decrease. A common mistake is failing to consider inflation risk. Investors sometimes overlook how inflation can erode returns, so always calculate the real return alongside nominal figures.