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A newly issued bond pays its coupons once a year. Its coupon rate is 4.9%, its maturity is 10 years, and its yield to maturity is 7.9%.
a) Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 6.9% by the end of the year.
b. If you sell the bond after one year when its yield is 6.9%, 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.
c. What is the after-tax holding-period return on the bond?
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 6.9% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 2.9% interest rate.
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.
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