Dynamo Corporation has semiannual bonds outstanding with 12 years to maturity, and the bonds are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price? Round your final percentage answer to two decimal places.

Question

Quizplus · Accepted Answer

To calculate the EAR, we need to first calculate the semiannual yield, which can be found using the bond pricing formula: 
Current Price = (Coupon Payment / Yield) x [1 - (1 / (1 + Yield)^n)] + (Face Value / (1 + Yield)^n)
where n is the number of periods (semiannual periods, in this case) and Yield is the semiannual yield. 
Plugging in the values we know, we get: 
$1,080.29 = ($40 / Yield) x [1 - (1 / (1 + Yield)^24)] + ($1,000 / (1 + Yield)^24)
Solving for Yield using a financial calculator or trial and error, we find that the semiannual yield is 3.5%. 
To convert this to an EAR, we use the formula: 
EAR = (1 + Semiannual Yield)^2 - 1 
Plugging in the value we just found, we get: 
EAR = (1 + 0.035)^2 - 1 = 7.12%
So, the best choice is C, with an EAR of 7.12%.

Dynamo Corporation Has Semiannual Bonds Outstanding with 12 Years to Maturity