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I came across a question in BPP study text :
“Henryted has 12% irredeemable bonds in issue with a nominal value of $100. The market price is $95 ex interest. Calculate the cost of capital if interest is paid half-yearly.”Solution:
“If interest is 12% annually, therefore 6% is payable half-yearly.
Cost of loan capital = (1+6/95)^2 -1 = 13.0%Please help me with this as i don;t get why the 1s are. And also please let me know how the calculations would be if it is paid, say, quarterly or every 4 months and also if interest is paid every 2 years (which might be rare).
To the best of my memory, this has never been asked in the exam (interest has always been annual).
If it is asked, then the half yearly interest is 6/95. To turn this into a yearly effective rate, then 1 + the yearly rate = (1 + half-yearly rate)^2
(For a full explanation as to why, watch the Paper F2 lectures on interest).
If it was payable quarterly, then 1 + yearly rate = (1 + quarterly rate)^4.
Paying it every 2 years will never ever happen in the exam!!
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