Wednesday, June 3, 2009

Practice Question - Real Return

Here is the sort of question that makes virtually all Series 65 and 66 candidates cringe at the testing center. With all the details provided, the question can hit you hard at first. Remember, your job at the testing center is to take a deep breath, then hit back.

What is your investor's real rate of return for holding the XYZ Light Corporation's 20-year bond with the following features:

  • Coupon rate 5%, paid semi-annually
  • Rating A-
  • Maturity date December 1, 2016
  • CPI 2%
  • Par value $1,000
  • Purchase price 90
  • Call date January 1, 2019
  • Call price 101 3/8.

    A) 5.00%.
    B) 3.50%.
    C) 2.50%.
    D) 4.50%.

    EXPLANATION: once you decide to ignore the credit rating, the par value, the call date, and the call price, you can start solving the question. Take the $50 in annual income divided by the $900 purchase price, which is 5.5%. Then, reduce that by the 2% rate of inflation (CPI) and choose 3.5%. Typical Series 65 question--like a bully, it seems scary at first. Then you learn how to deal with it, and, eventually, it ceases to be a problem.


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