Assume you have a 1-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays $1,000 at maturity. The second has an 8% coupon rate and pays the $80 coupon once per year. The third has a 10% coupon rate and pays the $100 coupon once per year. 1. If all three bonds are now priced to yield 8% to maturity, what are their prices? 2. If you expect their yields to maturity to be 8% at the beginning of next year, what will their prices be then? What is your before-tax holding-period return on each bond? If your tax bracket is 30% on ordinary income and 20% on capital gains income, what will your after-tax rate of return be on each? 3. Recalculate your answer to (2) under the assumption that you expect the yields to maturity on each bond to be 7% at the beginning of next year.
Assume you have a 1-year investment horizon and are trying to choose among three
bonds. All have the same degree of default risk and mature in 10 years. The first is a
zero-coupon bond that pays $1,000 at maturity. The second has an 8% coupon rate
and pays the $80 coupon once per year. The third has a 10% coupon rate and pays
the $100 coupon once per year.
1. If all three bonds are now priced to yield 8% to maturity, what are their prices?
2. If you expect their yields to maturity to be 8% at the beginning of next year, what
will their prices be then? What is your before-tax holding-period return on each
bond? If your tax bracket is 30% on ordinary income and 20% on capital gains
income, what will your after-tax
3. Recalculate your answer to (2) under the assumption that you expect the yields to
maturity on each bond to be 7% at the beginning of next year.
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