Seven years before it matures the value of a $1,000 strip bond is $672. What is the semi-annually compounded nominal interest rate?
A) 5.76%
B) 5.84%
C) 3.10%
D) 24.40%
E) 2.88%

Question

Quizplus · Accepted Answer

The value of a strip bond can be calculated using the formula for the present value of a single future amount: $PV = \frac{FV}{(1 + r)^n}$, where PV is the present value ($672), FV is the future value ($1,000), r is the semi-annual interest rate, and n is the number of periods (14, since the bond matures in 7 years and interest is compounded semi-annually). Rearranging the formula to solve for r gives us $r = (\frac{FV}{PV})^{1/n} - 1$. Plugging in the values gives $r = (\frac{1000}{672})^{1/14} - 1$, which calculates to approximately 0.0288 or 2.88% per period. Since the rate is semi-annual, the nominal annual interest rate is 2.88% * 2 = 5.76%.

Seven Years Before It Matures the Value of a $1,000