In: Finance
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.
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%.