Question

Determine the after-tax yield (i.e., IRR on the ATCF) obtained by an individual who purchases a $10,000, 10-year, 10% nominal interest rate bond. The following information is given:

--Interest is paid semi-annually, and the bond was bought after the fifth payment had just been received by the previous owner.

--The purchase price for the bond was $9,000.

--All revenues (including capital gains) are taxed at an income rate of 28%.

--The bond is held to maturity

Answer 1

Solution:

Given: Face Value of Bond = $10,000; Nominal Interest rate 10% paid semiannualy i.e. 6 month rate = 5%

Half yearly coupon payment = 10,000 * 5% = $500

Bond purchasd at $9000; on Maturity payment recived is $10,000, so gain on Maturity is $1000

Income and Gains are taxed at 28%.

Completing the table below.

Note: Bond purchased after 5th payment, hence there are 15 other semiannual payments to be received.

IRR on ATCF column gives value as 4.39%. This is a 6month value. Yearly Value = 4.39% * 2 = 8.78%.

Therefore, after tax yield = 8.78%

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