Question

A par value bond offers a coupon rate of 7 percent with semiannual interest payments. The effective annual rate provided by these bonds must be:

a. equal to 3.5 percent
b. greater than 3.5 percent but less than 4 percent
c. equal to 7 percent
d. greater than 7 percent but less than 8 percent
e. equal to 14 percent

Answer 1

The correct answer is A

Step-by-step explanation:

Computing the effective interest rate per payment period for the payment schedule which is semi- annual interest:

The formula to compute the effective interest rate which is provided by the bonds is as:

Effective rate (semi- annually) = Nominal rate (r) / Compounded quarterly (m)

where

r is 7%

m is 2 (every 6 months)

Putting the values above:

= 7% / 2

= 3.5%

Therefore, 3.5% is the effective annual rate offered by these bonds.