Question

Two corporate bonds, issued respectively by F Ltd and G Ltd, have the same face value of$10,000 and the same term to maturity of 7 years. F Ltd’s bonds have a coupon rate of 8% perannum, payable half-yearly, and G Ltd’s bonds have a coupon rate of 7.8% per annum, payablebi-monthly (that is, every 2 months). Calculate the effective annual return (EAR) on each bond.

 

Answer 1

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

 

Consider F ltd

r = 8% ⇒ 0.08.

n = 2 half years per year

 

Effective annual rate = (1+0.08/2)2-1

⇒ 1.04^2-1

⇒ 1.0816-1

⇒ 0.0816

⇒ 8.16%.

 

Consider G ltd:

r = 7.8% ⇒ 0.078

n = 6 bi monthly period every year

⇒ Effective annual rate = (1+0.078/6)^6-1

⇒ 1.013^6-1

⇒ 0.08057937

⇒ 8.06%.

Effective annual rate is 8.06%.