Unit 22

Question 1

An investor purchases a TIPS bond ..

Answer 1

The principal value of a TIPS bond is adjusted semiannually by the inflation rate. The exact calculation would be $1,000 × 104.5% × 104.5%, which equals $1,092.025. Each six months, the interest is paid on that adjusted principal, and that is why the security keeps pace with inflation. Obviously, the answer must be something a bit higher than $1,090 because of the semiannual compounding.

Question 1

Annualized rate of return is computed by

Answer 1

taking the investor’s total return and annualizing it.

Regular return x4 for a year

Question 2

The probable return is

Answer 2

an estimate of probable returns an investment may yield

Question 3

If you have capital gains tax

Answer 3

Then you’re taxed on capital gains vs your ordinary income

Question 4

The risk premium is

Answer 4

amount of total return in excess of the risk-free rate

Question 5

expected return on an equity investment is the

Answer 5

risk-free (for example, T-bill) rate of return added to the equity risk premium (3% + 4% = 7%).