A newly issued 10-year maturity, 4% coupon bond making annual coupon payments is

Question

A newly issued 10-year maturity, 4% coupon bond making annual coupon payments is sold to the public at a price of $890. The bond will not be sold at the end of the year. The bond is treated as an original-issue discount bond.

a. Calculate the constant yield price. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Constant yield price $ ....?

b. What will be an investor's taxable income from the bond over the coming year? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Taxable income $....?

Explanation / Answer

The bond is issued at a price of $890.

Therefore, its yield to maturity is 5.456%. [n= 10; PV = 890; FV = 1,000; PMT = 40]

Using the constant yield method, we can compute that its price in one year (when maturity falls to 9 years) will be (at an unchanged yield) $913.64,representing an increase of $23.64.

Total taxable income is: $40 + $ 23.64 = $ 63.64

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