On April 15, 2020, Cando Inc. sold $10,000,000 of five-year, 3% bonds for $9,972,469. From the proceeds, Cando paid its investment bank a $200,000 sales commission.
Interest is payable semi-annually on April 15 and October 15. What is the effective rate of interest (round to 2 decimal places)?
A)1.53%
B)1.75 %
C)3.00%
D)3.50%

Question

Quizplus · Accepted Answer

The effective interest rate can be calculated using the net proceeds from the bond sale (total proceeds minus any fees or commissions) and the stated interest rate. Here, the net proceeds are $9,972,469 - $200,000 = $9,772,469. The effective interest rate is higher than the stated rate because the bonds were sold at a discount. The correct answer is found by calculating the semi-annual yield to maturity (YTM) and then doubling it to annualize, which approximates to 1.75%.