The effective interest rate on bonds is lower than the stated rate when bonds sell

Question

Quizplus · Accepted Answer

When bonds sell above face value, it means investors are willing to pay more than the par value of the bond. This reduces the effective interest rate on the bond because the interest payments are based on the par value, not the higher selling price. For example, a bond with a face value of $1,000 and a stated interest rate of 5% would pay $50 in interest each year. However, if the bond sells for $1,200, the effective interest rate is actually 4.17% ($50/$1,200), not 5%.

The Effective Interest Rate on Bonds Is Lower Than the Stated