A newly issued bond pays its coupons once a year. Its coupon rate is 5.2%, its m

Question

A newly issued bond pays its coupons once a year. Its coupon rate is 5.2%, its maturity is 10 years, and its yield to maturity is 8.2%.

a. Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 7.2% 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 7.2%, 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 7.2% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 3.2% 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

a. With the information given, lets calculate the Bond price. Enter the following in the financial calculator

1/y = 8.2%; n=10; PMT = 52; FV = 1000; calculate PV = 800.5

Now after 1 year, yield to maturity is 7.2%, so calculating the price after 1 year.

1/y = 7.2%; n=9; PMT = 52; FV = 1000; calculate PV = 870.80

Now Buy price is 800.5 and we get a coupon of 52 and sale price after 1 year is 870.8. So total proceeds is 922.8

So holding period return is 922.8 - 800.5 / 800.5 = 122.3 / 800.5 = 15.27%

b) Tax on interet income is 40%. Interest income is $52. So tax paid is 20.8

Tax on capital gain is 30%. So capital gain is 870.8 - 800.5 = 70.3. So tax on this is 21.09

Total tax paid = 41.89

c) After tax proceds are 922.8 - 41.89 = 880.91

After tax holding period return = 880.91 - 800.5 / 800.5 = 80.41 / 800.5 = 10.04%

d) Now lets calculate the price of thebond after 2 years

1/y = 7.2%; n=8; PMT = 52; FV = 1000; calculate PV = 881.49

Coupon received at the end of 1st year is invested at 3.2% interst. Value of 52 (couppn paid after year 1) at the end of second year = 52*1.032 = 53.664

Total payments received at the end of second year = 53.664 + 52 (second eyar coupon) + 881.49 = 987.154

Compounded yield for 2 years = 987.154 - 800.5 / 800.5 = 186.654 / 800.5 = 23.3%

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