Question 1 A loan stock was issued bearing quarterly coupons payable at a rate of 12% per annum. The loan stock is repayable at 115% on any coupon payment date between 10 and 20 years from issue, at the option of the borrower. An investor, who is liable to tax on income at a rate of 35% and on capital gains at a rate of 25%, intends to buy 100,000 unit nominal stock on the issue date. The investor aims to achieve a net yield on this investment of 8% per annum. (i) Determine whether the investor would make a capital gain if the bond is held until redemption. [2 marks] (ii) In what way does your answer to part (i) affect the assumption made for calculating the issue price? Explain in general terms the reasoning behind the pricing approach. [3 marks] (iii) Hence, calculate the maximum price that the investor should pay that ensures that the net yield indicated in part (i) is obtained irrespective of when the bond is redeemed. [6 marks] (iv) The bond is bought at issue at the price calculated in part (iii). The entire stock is then sold exactly 4 years later to a new investor at a price that ensured a minimum net redemption yield of 6% per annum. The new investor is subject to the same income tax rate as the original investor, but pays no capital gains tax. Making use of the sale price, calculate the net annual yield achieved by the first investor, to the nearest 0.1%, for the period over which the stock was held. [14 marks] Question 1 A loan stock was issued bearing quarterly coupons payable at a rate of 12% per annum. The loan stock is repayable at 115% on any coupon payment date between 10 and 20 years from issue, at the option of the borrower. An investor, who is liable to tax on income at a rate of 35% and on capital gains at a rate of 25%, intends to buy 100,000 unit nominal stock on the issue date. The investor aims to achieve a net yield on this investment of 8% per annum. (i) Determine whether the investor would make a capital gain if the bond is held until redemption. [2 marks] (ii) In what way does your answer to part (i) affect the assumption made for calculating the issue price? Explain in general terms the reasoning behind the pricing approach. [3 marks] (iii) Hence, calculate the maximum price that the investor should pay that ensures that the net yield indicated in part (i) is obtained irrespective of when the bond is redeemed. [6 marks] (iv) The bond is bought at issue at the price calculated in part (iii). The entire stock is then sold exactly 4 years later to a new investor at a price that ensured a minimum net redemption yield of 6% per annum. The new investor is subject to the same income tax rate as the original investor, but pays no capital gains tax. Making use of the sale price, calculate the net annual yield achieved by the first investor, to the nearest 0.1%, for the period over which the stock was held. [14 marks]
