Question

A newly issued bond pays its coupons once a year. Its coupon rate is 4.3%, its maturity is 10 years, and its yield to maturity is 7.3%.

a.Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 6.3% by the end of the year. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Holding-period return % 14.71

b. If you sell the bond after one year when its yield is 6.3%, 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 6.3% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 2.3% 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

1) Lets first calculate the price of the bond today.

Input the following in the financial calculator

FV = 100, 1/y = 7.3%, PMT = 4.3; n=10; calculate PV = 79.22

Now lets calcualte the Bond price at the end of year 1

FV = 100, 1/y = 6.3%, PMT = 4.3; n=9; calculate PV = 86.57

Now if you hold for 1 year, you get a coupon of 4.3 and sale value of 86.57 which is a total of 90.87

in %age terms it is gain of 90.87 - 79.22 / 79.22 = 14.71%

2) Capital gain is 86.57 - 79.22 = 7.35. Thus tax on capital gain is 7.35*30% = $2.205

Tax on interest income = 4.3*40% = $1.72

Total taxes = 2.205 + 1.72 = $3.925

3) After tax holding period return = 90.87 - 79.22 - 3.925 / 79.22 = 9.75%

4) After 2 years, the bond price would be

FV = 100, 1/y = 6.3%, PMT = 4.3; n=8; calculate PV = 87.73

Coupond of 4.3 is invested at 2.3%, so that becomes 4.3985

Now total proceeds at the end of 2 years is 87.73 + 4.3985 + 4.3 (couppon at the end of second year) = 96.4285

Now compound yield is r (say)

then 79.22*(1+r)^2 = 96.4285

r = 10.33%