You are given the following information with respect to a bond:

• par value: 1000
• term to maturity: 3 years
• annual coupon rate: 6% payable annually

You are also given that the one, two, and three year annual spot interest rates are 7%, 8%, and 9% respectively. The bond is sold at a price equal to its value.

Calculate the annual effective yield rate for the bond i.

• 8.1%
• 8.3%
• 8.5%
• 8.7%
• 8.9%

Copyright 2023 . The Society of Actuaries, Schaumburg, Illinois. Reproduced with permission.

Solution: E.

Using spot rates, the value of the bond is:

60 /1.07 + 60 /1.08² + 1060 /1.09³ = 926.03.

Using a calculator, the solution is 8.9%.

Copyright 2023 . The Society of Actuaries, Schaumburg, Illinois. Reproduced with permission.