Assume you have a 1-year investment horizon and are trying to choose among three bonds. All have
Question:
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.
a. If all three bonds are now priced to yield 8% to maturity, what are the prices of: (i) the zerocoupon bond; (ii) the 8% coupon bond; (iii) the 10% coupon bond?
b. If you expect their yields to maturity to be 8% at the beginning of next year, what will be the price of each bond?
c. What is your before-tax holding-period return on each bond?
d. If your tax bracket is 30% on ordinary income and 20% on capital gains income, what will be the after-tax rate of return on each bond?
e. Recalculate your answers to parts (b)–
(d) 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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