Business Accounting volume 4

Cover Business Accounting volume 4
Business Accounting volume 4
Harold Dudley Greeley
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5. Nominal Interest vs. Effective Interest With respect to all bonds bought above or below par there are always two rates of interest involved : ( 1 ) a nominal or cash rate, which is a certain percentage of par and which is indicated by the coupons; and (2) an BONDS AND BOND INVESTMENTS 127 effective or income rate, which is a certain percentage of the amount originally invested and remaining invested. The effective or income rate is the actual return received on the price paid for the bond. T
...hus, ten $100 bonds bought at a premium of 10% would cost $1, 100. As- suming that the nominal rate of interest is 6% payable annually, the investment of $1, 100 would yield an annual return of $60. Therefore, if $1, 100 yields $60 interest, $100 would yield 1/11 of this sum, or $5. 45, or 5. 45% interest, which is the effective yield on the bonds.
In actual practice the determination of the effective interest rate is rarely so simple a problem as in the fore- going example. Bonds run for many years and are usually purchased as a permanent investment rather than as a speculation, and therefore as a rule many in- terest dates must elapse before the time of their re- demption.


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