A newly issued bond pays its coupons once a year. Its coupon rate is 4.7%, its m

Question

A newly issued bond pays its coupons once a year. Its coupon rate is 4.7%, its maturity is 15 years, and its yield to maturity is 7.7%.

a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 6.7% 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 6.7%, 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 6.7% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 2.7% 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             %

Suppose that today’s date is April 15. A bond with a 10% coupon paid semiannually every January 15 and July 15 is listed in The Wall Street Journal as selling at an ask price of 1,011.667. If you buy the bond from a dealer today, what price will you pay for it? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Invoice price            $

Explanation / Answer

Question :Suppose that today’s date is April 15. A bond with a 10% coupon paid semiannually every January 15 and July 15 is listed in The Wall Street Journal as selling at an ask price of 1,011.667. If you buy the bond from a dealer today, what price will you pay for it?

Answer: April 15 is midway through the semi-annual coupon period. Therefore, the invoice price will be higher than the stated ask price by an amount equal to one-half of the semiannual coupon. The ask price is 1,011.667 , so the invoice price is:$1,011.667 + (1/2 * $50) = 1,011.667 + 25 = $1,036.67

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