Calculate the net effective yield, Cost Accounting

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A Government issued a number of index-linked bonds on 1 June 2000 which were redeemed on 1 June 2002.  Each bond had a nominal coupon rate of 3% per annum, payable half yearly in arrears, and a nominal redemption price of 100.  The actual coupon and redemption payments were indexed according to the increase in the Retail price index between 6 months before the bond issue date and 6 months before the coupon or redemption payment rates.

The values of the Retail price index in the relevant months were:

Date

Retail price index

December 1999

100

June 2000

102

December 2000

107

June 2001

111

December 2001

116

June 2002

120

(i) An investor purchased $100,000 nominal of bonds at the issue date, and held them until they were redeemed. The issue price was $94 per $100 nominal. Calculate all the investor's cash flows from this investment, before tax.

(ii) The investor is subject to income tax at a rate of 30% and capital gains tax at a rate of 20%.  When calculating the amount of capital gain which is subject to tax, the price paid for the investment is indexed in line with the increase in the Retail price index for the period between the month in which the investment was purchased and the month in which it was redeemed.

  • Calculate the investor's capital gains tax liability in respect of this investment.                                                                                                                       
  • Calculate the net (of all taxes) effective yield per annum obtained by the investor on these bonds.

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