Question

2) A person paid $1,040 for a five year, $1,000, 8% bond.

Required:

1. a) Determine how much cash the bondholder will receive each year as interest.

2. b) Determine the amount of cash the bondholder will receive for his return on investment

   and the return of his investment for the $1,000 bond. Be sure to show your work.

3. c) Determine if the effective (market) interest rate is less than, equal to, or greater than

   12%.

Answer 1

Answers

· [a] Cash to be received each year as interest = $ 1000 x 8% = $ 80

· [b]
Amount of cash received by bondholder will include:
>Interest amount of $ 80 x 5 years = $ 400
>Investment amount = $ 1000

· [c]
Effective interest rate is LESS than 12%
This is because Issue price is MORE than face value of Bonds, which states that issuer is charging premium for providing HIGHER stated interest rate, while market rate is below than 8%.