Hi, please help to explain the below question and also the meaning of 8-5/8%. Thanks
The cum-coupon transaction price is 125-3/16 for a semi-annual pay, 8-5/8% coupon bond. 2 months have elapsed since the past coupon payment. What is the accrued interest on 2000 000 par value for this bond.
Solution: (2/6)*(1/2)*(8-5/8%)*2000000 = 28750
The question is asking you to calculate the amount of interest that is payable given that the bond is between interest payments. 8-5/8% is the same as 8.625% coupon rate. Since the bond pays semiannually, for this problem, you have to divide this coupon rate by 2.
The solution you provided indicates that two months out of the six month period between coupon payments has passed. This means that 2/6 of the interest has accrued. The 1/2 is necessary because the bond pays semi-annually. Therefore, the stated annual rate of 8-5/8% must be divided by 2. All of this multiplied by the principal gives the total amount of interest that has accrued in two months.
As an example, the total amount paid every six months is $86,250. If the bond holder wanted to sell it now, the purchaser of the bond would have to remit 2/6 of the total interest accrued, or $28,750.