Question

You buy a 9-year $1,000 par value 5.00% annual-payment coupon bond priced to yield 7.00%. You do not sell the bond at year-end. If you are in a 15% tax bracket, at year-end you will owe taxes on this investment equal to _______.

Answer 1

Given about a bond,

Years to maturity = 9 years

Face value = $1000

Coupon rate = 5%

=> annual coupon payment = 5% of 1000 = $50

Yield = 7%

So, current price of the bond can be calculated on financial calculator using following values:

FV = 1000

PMT = 50

N = 9

I/Y = 7

compute for PV, we get PV = -869.70

=> Purchase price of the bond P = $869.70

After 1 years, years left to maturity is 8 years,

Now use following values to compute price,

FV = 1000

PMT = 50

N = 8

I/Y = 7

compute for PV, we get PV = -880.57

So, if bond of sold at S = $880.57

So, profit on the bond = (S - P + C) = 880.57 - 869.70 + 50 = $60.88

tax rate = 15%

So, tax owed on investment = 0.15*60.88 = $9.13