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.
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%.