You buy a zero coupon bond at the beginning of the year that has a face value of

Question

You buy a zero coupon bond at the beginning of the year that has a face value of $1,000, a YTM of 7 percent, and 25 years to maturity. You hold the bond for the entire year.

How much interest income will you have to declare on your tax return? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

You buy a zero coupon bond at the beginning of the year that has a face value of $1,000, a YTM of 7 percent, and 25 years to maturity. You hold the bond for the entire year.

Explanation / Answer

You would have paid $184.25 for this bond. If it is a taxable bond (not a municipal bond or not in a deferred tax account, as an IRA), then you have taxable income each year to the extent of the compound interest accrued that year, even though you will not receive any cash until maturity in 25 yrs.

In yr 1, taxable income will be 12.90 (7% of 184.25) In yr 2, 7% of 197.15, or 13.80, etc. Over 25 yrs, you will earn 815.75. (1,000 - 184.25)

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