A newly issued bond has a coupon rate of 7 percent and semiannual interest payments. The bonds are currently priced at par. The effective annual rate provided by these bonds must be:

Answer: 7.12%

Explanation:

Effective Annual Interest rate is the nominal interest rate adjusted for the number of compounding periods a financial product will experience in a period of time.

To calculate the Effective Annual Rate one can use the following formula,

Effective Rate of Interest = (1+r/m) ^m - 1

where r is the rate and

M is the no of compounding periods per year which in this case would be 2 because the payments are semi annual

Plugging in figures would give us,

Effective Rate of Interest = (1+0.07/2) ^2 - 1

=0.0712

= 7.12%

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