A newly issued bond pays its coupons once annually. Its coupon rate is 4%, its maturity is 10 years, and its yield to maturity is 7%.
a . Find the holding-period return for a 1-year investment period if the bond is selling at a yield to maturity of 6% by the end of the year.
b. If you sell the bond after 1 year, what taxes will you owe if the tax rate on interest income is 35% and the tax rate on capital gains income is 30%? The bond is subject to original-issue discount tax treatment.
c. What is the after-tax holding-period return on the bond?
d. Find the realized compound yield before taxes for a 2-year holding period, assuming that (1) you sell the bond after 2 years, (2) the bond yield is 6.5% at the end of the second year, and (3) the coupon can be reinvested for 1 year at a 2.5% interest rate.
e. Use the tax rates in (b) above to compute the after-tax 2-year realized compound yield. Remember to take account of OID tax rules.