Question

Generic Inc. issued bonds in 1988 that will mature 16 years from the date of issue. The bond pays a 14.375 percent coupon and the interest is paid semiannually. Its current price is $1,508.72. What is the effective annual yield on the bonds?

Answer 1

The effective annual yield on the bonds is 5.2196%.

Step-by-step explanation:

The effective annual yield on the bonds can be calculated using the formula:

Effective annual yield = (1 + periodic interest rate)^n - 1

where n is the number of compounding periods per year. In this case, the bond pays interest semiannually, so there are 2 compounding periods per year. The periodic interest rate is half of the stated annual coupon rate, so it is 14.375% / 2 = 7.1875%. Plugging these values into the formula, we get:

Effective annual yield = (1 + 0.071875)^2 - 1

Effective annual yield = 0.071875^2 = 0.052196

Therefore, the effective annual yield on the bonds is 0.052196, or 5.2196%.

Answer 2

8.93%

Step-by-step explanation:

If we want to determine the effective annual yield on the bonds we must calculate the yield to maturity of the bonds:

YTM = {coupon + [(face value - market value)/n]} / [(face value + market value)/2]

YTM = {71.875 + [($1,000 - $1,508.72)/32]}/ [($1,000 + $1,508.72)/2]

YTM = 55.9775 / 1,254.36 = 0.04463 x 2 semiannual coupons = 8.93%