Reference no: EM133060928

We have done some examples of holding period returns in class, and this assignment will ask you to calculate this number for several investments. As a reminder, a holding period return is the total return you earn on your investment over the time period you own it. The calculation is: (Sale price + Dividends or coupon payments) / Purchase Price - 1. So for example, if I buy a stock for $10, receive $1 in dividends, and sell it for $12, my holding period return is (12 + 1) / 10 - 1 = 30%.

1. 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 semiannually. The third has a 10% coupon rate and pays the $100 coupon semiannually.

a. If all three bonds are now priced to yield 8% to maturity, what are their prices?

b. If you expect their yields to maturity to still be 8% one year from now, what will their prices be then? What is your before-tax holding-period return on each bond? If your tax bracket is 30% on ordinary income and 20% on capital gains income, what will your after-tax rate of return be on each? Recall that your holding period return will include both the price return and the coupons received: (Price in 1 year + coupons) / (Original purchase price) - 1. Ordinary income rates apply to coupon payments and capital gains rates apply to the price appreciation (the difference between sale price and purchase price).

c. Recalculate your answer to (b) under the assumption that you expect the yields to maturity on each bond to be 7% one year from now.