Assume that the State of Florida sold tax-exempt,zero coupon bonds with a $1,000 maturity value 5 years ago.The bonds had a 25-year maturity when they were issued,and the interest rate built into the issue was 8 percent,compounded semiannually.The bonds are now callable at a premium of 4 percent over the accrued value.What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today?

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Quizplus · Accepted Answer

The correct answer is D.The effective annual rate of return is the rate that would have produced the same total return over the life of the bond if it had been paid out in equal annual payments. To calculate the effective annual rate of return, we can use the following formula:EAR = (FV / PV)^(1/n) - 1where:EAR is the effective annual rate of returnFV is the future value of the bondPV is the present value of the bondn is the number of yearsIn this case, the future value of the bond is $1,000, the present value of the bond is the price that the investor paid for it when it was issued, and the number of years is 5. We can calculate the present value of the bond using the following formula:PV = FV / (1 + r/2)^(2n)where:PV is the present value of the bondFV is the future value of the bondr is the interest raten is the number of yearsIn this case, the future value of the bond is $1,000, the interest rate is 8%, and the number of years is 25. We can calculate the present value of the bond as follows:PV = 1000 / (1 + 0.08/2)^(2*25) = $376.89Now we can calculate the effective annual rate of return as follows:EAR = (1000 / 376.89)^(1/5) - 1 = 0.0901 = 9.01%

Assume That the State of Florida Sold Tax-Exempt,zero Coupon Bonds