A newly issued bond pays its coupons once a year. Its coupon rate is 4.6%, its m

Question

A newly issued bond pays its coupons once a year. Its coupon rate is 4.6%, its maturity is 10 years, and its yield to maturity is 7.6%.

a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 6.6% 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 6.6%, 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.)

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 6.6% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 2.6% 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             %

Explanation / Answer

Iniital value of bond
=pv(rate,nper,pmt,fv,type)
=pv(7.6%,10,(1000*4.6%),1000,0)
=795.01
At end of one year the value of bond can be found using pv formulae in excel
=pv(rate,nper,pmt,fv,type)
=pv(7.6%,9,(4.6%*1000),1000,0)
=867.45
Return=(final+coupon-initial)/initial
=(867.45+(1000*4.6%)-795.01)/795.01
=14.90%

b)interest income=(1000*4.6%)=46
capital gain=(867.45-795.01)=72.44
Tax on interets income=40%*46=18.40
Tax on capital gain=30%*72.44=21.73
Total tax=18.4+21.73=40.13

c)After tax return on bond=(867.45+(1000*4.6%)-795.01-40.13)/795.01
=9.85%

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