Accounting finding effective interest rate
The effective interest rate of this bond is $60 / $800 or 7.5%. If the central bank reduced interest rates to 4%, this bond would automatically become more valuable because of its higher coupon rate. If this bond then sold for $1,200, its effective interest rate would sink to 5%. The Effective Annual Rate (EAR) is the interest rate that is adjusted for compounding over a given period. Simply put, the effective annual interest rate is the rate of interest that an investor can earn (or pay) in a year after taking into consideration compounding. Effective interest rate is the annual interest rate that when applied to the opening balance of a loan amount results in a future value that is the same as the future value arrived at through the multi-period compounding based on the nominal interest rate (i.e. the stated interest rate).