Question of the Week

Jane and Fabbio Salvatore have just discovered that a Fabulous Florence municipal bond will be offered to support a bridge development in Fabbio's hometown in Florence, OH. They want to purchase the bond at $1,000, but end up buying the 10% bond at $1,020. One year later, the Salvatores want to sell and earn a profit when the market value is at $1,000. Calculate the total return of the Fabulous Florence bond.

a) 9.98%
b) .0196%
c) 12%
d) 2%

Answer:

The correct answer is a).

The test will try to confuse you by adding extra details to the questions. It doesn't matter that the Salvatores wanted to buy at $1,000 when, in fact, they bought at $1,020. Furthermore, one year later when the market is at $1,000, their bond has actually depreciated. Only 9.98% could be the answer. The total return will reflect the interest earned (yield) plus or minus any appreciation or depreciation (growth). While the bond earns 10% interest, it has lost nearly 1% of its value and delivers a total return of 9.98%. ($1,020-$1,000 = $20)/$1,020 = .0196%. (10% + (-.0196%) = 9.98%.

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