Question

You want to invest 50.000 TL at the beginning of each year for the next 6 years. You have got following options: If you deposit your money in the bank, you get 6% interest income per year. Also, if you invest your money in a 3-year government bond, you can get 5.5% per year and have a current market price equal to 92% of face value. However, the government deducts 12% tax per year from the interest income you get from government bond. How should your investment be planned ?

Answer 1

YTM of the government bond (r) is given by (assuming face value of $1000)

55/r*(1-1/(1+r)^3) + 1000 /(1+r)^3= 920

However , as 12% tax is deducted from Interest , only 55*0.88 = 48.4 is available

So, after tax YTM (r) is given by

48.4/r*(1-1/(1+r)^3) + 1000 /(1+r)^3= 920

Solving for r, r= 0.0794 or 7.94%

As the return is higher, the 50000 TL for the 1st year should be invested in the government bond and the remaining amount every year as well as the coupon payments (after tax) must be reinvested in the bank account paying 6%