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Question 8 An investor purchased a bond with exactly 18 years to redemption. The bond, redeemable at 115%, has a gross redemption yield of 4%
Question 8 An investor purchased a bond with exactly 18 years to redemption. The bond, redeemable at 115%, has a gross redemption yield of 4% per annum and pays a coupon of 5.5% per annum half-yearly in arrears. The investor does not pay tax on income or capital gains. (0) Calculate the purchase price per 100 nominal paid for the bond. [3 marks] (ii) After exactly six years, immediately after payment of the coupon then due, this investor sells the bond to another investor. The buyer pays income tax at a rate of 40% and capital gains tax at a rate of 25%. The bond is purchased by the second investor at a price that provides an effective net redemption yield (i.e. after tax) of 4% per annum. (a) Calculate the price per 100 nominal paid by the second investor. [4 marks] (b) Calculate, to the nearest 0.1%, the annual effective rate of return earned by the first investor during the period for which the bond was held. [4 marks] (c) Briefly explain why your answer to part (ii) (b) above is lower than the gross redemption yield of 4% per annum, which is the return the first investor would have achieved had the bond been held until maturity. [2 marks]
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