Answer to Question #300095 in Management for Nana

Question

A. Using a practical example, explain what is meant by an Effective Annual Interest Rate?

B. Z LTD bond has a 10 percent coupon rate and K1000 fax value. Interest is paid semi annually, and the bond has 20 years to maturity. If investors require a 12 percent yield, what is the value of the bond? Also determine the effective annual yield on this bond?

C. Nkandu has a K10 000 to invest in stock portfolio on LuSE. He intends to invest in Stock X with an expected return of 14% and stock Y with an expected return on 10.5 percent. If his goal is to create a portfolio that will generate a return of 12.4 percent, how much money should he invest in Stock X and Stock Y?

Answer 1

Effective annual interest rate is the real return on savings account or any interest paying investment when the effects of compounding overtime are taken into account. If for example, a loan with a stated interest rate of 30% that is compounded monthly, the effective annual interest rate will be 35%. Banks will typically advertise the stated interest rate at 30% instead of the effective rate of 35%.

Value of bond$=$ fax value$×$ bond rate.

$=1000×10$ %$=$ $K10,000$ per year