Question

There is a bond that has a quoted price of 105.957 and a par value of $2,000. The coupon rate is 6.90 percent and the bond matures in 24 years. If the bond makes semiannual coupon payments, what is the effective annual interest rate?

Answer 1

Answer:

The effective annual interest rate is 7.02%.

Explanation:

The effective annual rate can be computed using the following formula:

EAR = ((1 + (i / n))^n) - 1 .............................(1)

Where;

i = Stated coupon rate = 6.90%, or 0.069

n = Number of compounding periods in a year = 2

Substituting the values into equation (1), we have:

EAR = ((1 + (0.069 / 2))^2) - 1

EAR = 1.07019025 - 1

EAR = 0.07019025, or 7.019025%

Approximating to 2 decimal places, we have:

EAR = 7.02%

Therefore, the effective annual interest rate is 7.02%.