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Assume that the City of Tampa sold an issue of $1,000 maturity value, tax exempt

ID: 2766746 • Letter: A

Question

Assume that the City of Tampa sold an issue of $1,000 maturity value, tax exempt (muni), zero coupon bonds 5 years ago. The bonds had a 25-year maturity when they were issued, and the interest rate built into the issue was a nominal 10 percent, but with semiannual compounding. The bonds are now callable at a premium of 10 percent over the accrued value. What effective annual rate of return would an investor who bought the bonds when they were issued and who still owns them earn if they were called today? Please show work

Explanation / Answer

The initial price of the bond at which they were bought

= par Value /discounted at 10% semi annual compunding =1000/(1.05)^50 =87.20

Now Accrued value in 5 years = 87.20*(1.05)^10 =142.045

Now it will calaled at 10% above accued value

=142,045* 1.1 =156.250

So Annual return

=(156.20/87.20)^(1/5)-1

=12.37%