Question

A newly issued bond pays its coupons once a year. Its coupon rate is 4.9%, its maturity is 10 years, and its yield to maturity is 7.9%.

a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 6.9% by the end of the year. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Holding-period return             %

b. If you sell the bond after one year when its yield is 6.9%, what taxes will you owe if the tax rate on interest income is 40% and the tax rate on capital gains income is 30%? The bond is subject to original-issue discount (OID) tax treatment. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Tax on interest income	$
Tax on capital gain	$
Total taxes	$

c. What is the after-tax holding-period return on the bond? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

After-tax holding-period return             %

d. Find the realized compound yield before taxes for a two-year holding period, assuming that (i) you sell the bond after two years, (ii) the bond yield is 6.9% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 2.9% interest rate. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Realized compound yield before taxes             %

e. Use the tax rates in part (b) to compute the after-tax two-year realized compound yield. Remember to take account of OID tax rules. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

After-tax two-year realized compound yield             %

Answer 1

4.90% Bond Coupon rate Maturity (yrs) YTM Price 10 7.90% $797.79 PV (7.9%,10,4.9%*1000, 1000,) 4.90% After 1 year Coupon rate Maturity (yrs) YTM Price 6.90% $869.14 PV(6.9%,9,4.9%*1000, 1000) So HPR 15.09% Tax rate on interest Tax on interest Tax rate on capital gains Tax on capital gains Total tax 40% 19.60 40%*4.9%*1000 30% 48.41 30%*(869.14-707.79) 68.01 After tax HPR 6.56% 4.90% After 2 year Coupon rate Maturity (yrs) YTM Price 6.90% $880.11 PV(6.9%,8,4.9%*1000, 1000,) coupon reinvested at 2.9% 50.42 So HPR 10.81% ((50.42+880.11+4.9%*1000)/797.79)^0.5-1 HPR after taxes Tax on 1st coupon Tax on second coupon Tax on capital gains Total tax 20.168 40%*50.42 19.600 49*40% 24.696 30%*(880.11-797.79) 64.464 HPR 7.10% ((50.42+880.11+4.9%*1000-64.464)/797.79)^0.5-1