Question

You lend $131 today and receive a promise for repayment 10 years from now of $240. What is implied effective annual interest rate? Round your answer to 4 decimal places. For example if your answer is 3.205%, then please write down 0.0321

Answer 1

The question is solved by first calculating the yield to maturity.

Information provided:

Present value= $131

Future value= $240

Time= 10 years

The yield to maturity is calculated by entering the below in a financial calculator:

FV= 240

PMT= -131

N= 10

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 6.24.

Therefore, the yield to maturity is 6.24%.

Effective annual rate is calculated using the below formula:

EAR= (1+r/n)^n-1

Where r is the interest rate and n is the number of compounding periods in one year.

EAR= (1+0.0624/1)^1 - 1

= 1.0624 - 1

= 0.0624.

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