Question

A newly issued bond pays its coupons once a year. Its coupon rate is 5.5%, its maturity is 10 years, and its yield to maturity is 8.5%. a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 7.5% by the end of the year. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Holding-period retum 15.47 % b. If you sell the bond after one year when its yield is 7.5%, 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 7.5% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 3.5% 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

a. Year end YTM 7.5% 12 Start year price Year end price $ $ 803.16 872.42 15.47% 18 Holding-period return 16 17 b. Constant yield price (2) Imputed interest 19 Tax on interest income Tax on capital gain Total taxes $ 816.43 $ 13.27 $ 27.31 $16.80 $44.11 23 C. After-tax holding-period return 9.98% 25 d. Price in year 2 26 Coupon income total income Realized compound yield before taxes $882.85 $ 111.93 $ 994.78 11.29% 28

A 31 32 33 34 35 36 37 38 39 40 41 e. Coupon in first year Tax on coupon Tax on imputed interest Net cash flow in first year After tax rate of return on reinvestments Net cash flow value at year 2 Constant price year 3 Imputed interest in year 2 Selling price of bond in yr 2 Tax on imputed interest Coupon yr 2 net of tax Capital gains tax on sales CF from yr 1 $55.00 -$22.00 -$5.31 $27.69 2.10% 28.27 $830.82 $14.40 $882.85 -$5.76 $33.00 -$15.61 $28.27 $922.76 42 43 44 45 After-tax two-year realized compound yield 7.19%

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