A:
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%
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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