A firm issues three-month commercial paper with a $250,000 face value and receives $244,000.What is the EAR the firm is paying for these funds?

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) can be calculated using the formula for EAR = [(1 + i/n)^n] - 1, where i is the interest rate and n is the number of compounding periods per year. However, in this case, since commercial paper is typically a discount instrument and does not compound, we can simplify the calculation by focusing on the discount and the term of the instrument. The firm receives $244,000 for paper worth $250,000 at maturity, implying a $6,000 interest (discount) over three months. To annualize: ($6,000/$244,000) * (12/3) = 0.102 or 10.2%.

A Firm Issues Three-Month Commercial Paper with a $250,000 Face