A firm has issued $1,000 bonds with a 3% coupon interest rate paid semi-annually. The bonds mature 10 years from now and may be purchased for $800 each. What effective annual rate of return would you receive if you purchased the bond now and held it to maturity 10 years from now

5.72%

Explanation:

Calculation for the effective annual rate of return

First step is to find the rate using financial calculator

Number of years = 10*2 = 20

Present value =PV = -800

PMT = [3%/2] * 100 = 15

FV = 1000

Using financial calculator we are going to press the CPT then the I/Y which will gives us 2.82% as the rate

Hence,

Periodic Rate = 2.82%

Last step is to calculate the effective annual rate of return

Using this formula

Effective Annual Rate = [1 + Periodic Rate]^Number of compounding periods in a year - 1

Let plug in the formula

Effective Annual Rate = [1 + 0.0282]^2 - 1

Effective Annual Rate = 1.0572 - 1

Effective Annual Rate = 0.0572 *100

Effective Annual Rate =5.72%

Therefore the effective annual rate of return will be 5.72%

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