Final answer:
The correct answer is the effective rate, which is the rate of interest actually earned by bondholders, capturing both the interest payments and capital gains on a bond investment.
Step-by-step explanation:
The rate of interest actually earned by bondholders is called the effective rate. Bonds are essentially loans that investors make to corporations, cities, states, or the federal government, with the promise that the borrower will repay the amount borrowed and also a rate of interest over time. While the nominal, stated, or coupon rate refers to the interest rate that the issuer agrees to pay each year, the effective rate reflects the actual yield or total rate of return that the bondholder earns, including interest payments and capital gains. For instance, if an investor buys a bond for less than its face value—that is, at a discount—and holds it until its maturity, they will receive more than they initially paid. As a result, the effective rate will be higher than the nominal or coupon rate.
Consider an investor who purchases a bond at a price of $964, while the face value of the bond is $1,000, and the annual interest payment is $80 (8% coupon rate). If the bond is held until maturity, the investor will receive the $1,000 face value plus $80 for the last year's interest payment. The yield on the bond will be (($1,080 - $964) / $964) * 100 = 12%, reflecting the actual rate of return earned, which takes into account both the interest payments and the capital gains achieved due to the change in the bond's price.