Amalgamated Appliance Inc.has planned a 3-month issue of commercial paper with a face value of $25,000,000.The paper is set to sell at 98.5% of face value.What is the EAR?

Question

Quizplus · Accepted Answer

To find the EAR, we need to use the following formula:
EAR = (1 + (r/m))^m - 1
Where r is the annualized rate, and m is the number of compounding periods in a year.
In this case, the face value of the commercial paper is $25,000,000, and it is selling at 98.5% of face value, or $24,625,000. The discount is $375,000, which is the interest paid on the paper.
The interest rate, r, can be found by dividing the discount by the face value and multiplying by the number of periods in a year. Since the paper is a 3-month issue, there are four compounding periods in a year.
r = ($375,000 / $25,000,000) x (4/3) = 0.06 or 6%
Plugging this into the EAR formula, we get:
EAR = (1 + (0.06/4))^4 - 1 = 0.0623 or 6.23%
Therefore, the best choice is B.