A firm issues one-month commercial paper with a $500,000 face value and receives $495,000.What is the EAR the firm is paying for these funds?

Question

Quizplus · Accepted Answer

To calculate the EAR, we need to know the annualized rate for the one-month commercial paper. The difference between the face value ($500,000) and the amount received ($495,000) is the interest paid by the firm for 1 month ($5,000). 
Annualized rate = (Interest / Principal) x (12 / Number of months) 
Annualized rate = ($5,000 / $495,000) x (12 / 1) 
Annualized rate = 0.1212 or 12.12% 
Therefore, the EAR is 12.8%, which is closest to answer choice A.

A Firm Issues One-Month Commercial Paper with a $500,000 Face