X Corp issues a bond that is due in 5 years. The bond has no coupon. The investor buys the bond for $100,000. In 5 years, the investor will receive $100,000 times the movement in the S&P 500 from the date the bond was issued until it matures. The most the investor can receive is capped at $200,000 and the investor suffers losses as the S&P goes down until the S&P goes down by 90%. If that happened the investor will be entitled to receive 10% of their investment back even if the S&P went down by more than 90%. The issuer could have borrowed money for five years at a 5% interest rate.

a. How will this instrument be treated for tax purposes?

b. Assume that it is redeemed at maturity for $175,000. What is the amount of gain/loss? When and how will it be treated for tax purposes?

Assume that the investor was guaranteed to get her initial investment back at maturity, even if the S&P decreased in value.

c. How would the amount received at maturity ($175,000) be treated?