# Interest Rate

1. Understand the difference between a stated cash interest rate in a debt contract and an effective interest rate negotiated by the debtor and creditor.

2. Compute the price of a term bond when the stated cash interest rate is different from the effective interest rate.

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3. Determine the amount of interest to be compounded each period when the stated cash interest rate is different from effective interest rate.

4. Prepare all journal entries for a term bond when the stated cash interest rate is different from the effective interest rate.

The total present value of the cash flows promised by this bond at an annual 6 percent rate for four years is

\$173,256 (cash interest) plus \$792,090 (face value) or \$965,346. Smith will receive this amount on January

1, Year One and pays back \$50,000 per year for four years followed by a single payment of \$1 million.

Mathematically, that is equivalent to earning a 6 percent rate of interest each year for four years.