On pg.403 in Example 12.7 : A loan of £1,000 bears interest of 6% per annum payable yearly and will be redeemed at par after ten years. An investor, liable to income tax and capital gains tax at the rates of 40% and 30% respectively, buys the loan for £800. What is his net effective annual yield? The net income each year is 36, which is found from being the 4.5% of purchase price. But the question doesn't mention the rate of 4.5%, so how did it arrive at that value?
The net income is not found from being 4.5% of purchase price. Infact, this rate is found from the net income of £36. And £36 comes from : Net income = Gross income - income tax 36 = 1000×6% - 40% of 1000×6% 36 = 60 - 24
Bihari is correct. It doesn't matter what you pay for a loan when deriving interest. Interest is paid based on nominal and then subject to income tax. The nominal in this case is the £1000.
