Explain the concept of immunization. The conversation should include a discussion of both yield-to-maturity and realized compound yield.
Explain the concept of immunization. The conversation should include a discussion of both yield-to-maturity and realized compound yield.
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A newly issued bond pays its coupons once a year. Its coupon rate is 5.6%, its maturity is 20 years, and its yield to maturity is 8.6%. |
a. | Find the holding-period return for a one-year investment period if the bond is selling at a yield to maturity of 7.6% 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 7.6%, 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.) |
Tax on interest income | $ |
Tax on capital gain | $ |
Total taxes | $ |
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 7.6% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 3.6% 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 | % |