# Compounding

1. Identify the characteristics of a zero-coupon bond.

2. Explain how interest is earned on a zero-coupon bond.

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3. Understand the method of arriving at an effective interest rate for a bond.

4. Calculate the price of a zero-coupon bond and list the variables that affect this computation.

5. Prepare journal entries for a zero-coupon bond using the effective rate method.

6. Explain the term “compounding.”

7. Describe the theoretical problems associated with the straight-line method and identify the situation in which this method can still be applied.

Often, the final exchange price for a bond is the result of a serious negotiation process to determine the interest

rate to be earned. As an example, the potential investor might offer an amount that equates to interest at an annual

rate of 7 percent. The debtor could then counter by suggesting 5 percent with the two parties finally settling on a

price that provides an annual interest rate of 6 percent. In the bond market, interest rates are the subject of intense

negotiations. After the effective rate (also called the yield or negotiated rate) has been established by the parties,

the actual price of the bond is simply a mathematical computation.