Stated vs. Effective Interest Rate

Once we understand how the stated annual interest rate enables us to determine the annuity payments on the bond, we can incorporate the effective interest rate into this scenario.

While the stated interest rate is written into the bond contract and calculates annuity payments on the bond, the effective interest rate is set by the market and is used to determine the true allotment of the annuity payments towards interest vs. bond liability.

The effective interest rate can either be higher (discount), lower (premium), or the same value (par) as the stated annual interest rate. This distinction determines how the bond selling price compares to its face amount.

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