An interest rate of 20% per year, compounded monthly is (circle one): Effective

Question

An interest rate of 20% per year, compounded monthly is (circle one): Effective Annual Rate Nominal Annual Rate Effective Monthly Rate Nominal Monthly Rate Now, calculate the following: Calculate the Effective Annual Rate Calculate the Effective Quarterly Rate Calculate the Effective Monthly Rate Faisal is trying to figure out the price he should pay for a Corporate Bond with a $10,000 face value. His minimum acceptable return is 10% per year, compounded semi-annually. Erin, the company representative wants him to pay $8,000 for the bond and in return he will get a 6% coupon rate semiannually and the face value of the bond after 8 years. Will the investment meet Faisal's minimum acceptable return of 10% or is Erin trying to pull a fast one? SHOW WORK

Explanation / Answer

I can help you with the first part of your question.!!

8. An Interest rate of 20% per year,compounded monthly is Effective Monthly rate.

a)Effective annual rate= (1+i/n)^n-1

i=10

n=compounding periods

so EAR= (1+0.1/1)^1-1

EAR=10.00%

b)Effective quaterly rate= (1+0.1/4)^4 -1 =10.38%

c)Effective Monthly rate=(1+0.1/12)^12 -1=10.47%

2.Actually in second part of the question it is clear that investment will meet faisal minimum return as Faisal on 10% annual rate will pay $1000 each year.

But if Erin makes him pay $8000 at once and then 6% coupon semi annually = (8000-2000)*0.06=120

hence after 8 years=120*16=1920

Hence this is the profitable one.!!

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