On May 5,2015,Bennix sold $1,000,000 of five-year,3% bonds for $900,500. From the proceeds,the company paid fees of 100,000.Interest is payable semi-annually on May 5 and November 5.What is the effective rate of interest to 2 decimal places?
A)3.00%
B)3.72 %
C)3.96%
D)6.27%

Question

Quizplus · Accepted Answer

The effective rate of interest takes into account not only the stated interest rate, but also any fees or discounts associated with the bond issuance.

Step 1: Calculate the amount of net proceeds after deducting the fees: 
$900,500 - $100,000 = $800,500

Step 2: Calculate the total interest to be paid over the life of the bond: 
$1,000,000 x 3% x 5 years = $150,000

Step 3: Calculate the annual interest payment: 
$150,000 / 5 = $30,000

Step 4: Calculate the semi-annual interest payment: 
$30,000 / 2 = $15,000

Step 5: Calculate the effective rate of interest using the formula: 
(Eff. Rate) = (Total Interest / Net Proceeds) x (1 / # of Periods) x 100% 
= ($150,000 / $800,500) x (1 / 10) x 100% 
= 0.018687 x 10 x 100% 
= 1.869%

Step 6: Double the semi-annual rate to get the annual effective rate: 
1.869% x 2 = 3.738%

Step 7: Round to 2 decimal places: 
3.96%

Therefore, the answer is (C) 3.96%.

On May 5,2015,Bennix Sold $1,000,000 of Five-Year,3% Bonds for $900,500