Question

Clarrie has just bought a 14-year Treasury bond paying coupon semi-annually at j2 = 5% p.a. The bond matures at par.
a. [4 marks]Find Clarrie’s purchase price (per $100 face value, rounded to 3 decimal places) of this Treasury bond, allowing for a 30% tax on interest only, to give a yield of j2 = 3.2% p.a. (net). Draw a cash flow diagram that models this scenario to accompany your answer.
b. [4 marks]Find Clarrie’s purchase price (per $100 face value, rounded to 3 decimal places) of this Treasury bond, allowing for a 30% tax on interest only. The tax on interest is paid one year later (e.g., for the coupon payment at t = 0.5 year, the tax payment will be paid at t = 1.5 years.), to give a yield of j2 = 3.2% p.a. (net). Draw a cash flow diagram that models this scenario to accompany your answer.
c. [2 marks]Justify the difference in your answers to parts a. and b. above.
d. [6 marks]If Clarrie paid $95.268 per $100 face value for the bond, and was exempt from tax, what yield was associated with his purchase? Use linear interpolation to find this yield and express your yield as a j2 rate, to one decimal place.

Answer 1

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