A newly issued bond pays its coupons once annually. Its coupon rate is 7.2%, its maturity is 20 years, and its yield to maturity is 9%.

Required:

A. Find the holding-period return for a 1-year investment period if the bond is selling at a yield to maturity of 8% by the end of the year.

B. If you sell the bond after one year, what taxes will you owe if the tax rate on interest income is 40% and the tax rate on capital gains income is 30%? The bond is subject to original-issue discount tax treatment.

C. What is the after-tax holding-period return on the bond?

D. Find the realized compound yield before taxes for a 2-year holding period, assuming that (i) you sell the bond after two years, (ii) the bond yield is 8% at the end of the second year, and (iii) the coupon can be reinvested for one year at a 3% interest rate.

E. Use the tax rates in part (b) to compute the after-tax 2-year realized compound yield. Remember to take account of OID tax rules.