Hello there, I am a bit confused why in part i of the question attached below the present value of the coupons is not multiplied by the factor (1-0.25) since the question states that "The investor pays tax at 25% on the coupons only", this does mean he pays income tax? Solution also attached Thanks in advance, Polina
The trick lies with the redemption yield. If we had been given a net redemption yield then it would have been correct to take account of the tax in the cash flows. We are given a gross redemption yield and we should take cash flows without the tax deduction.
Thank you very much for this, helped a lot - but my new question is for part ii) b), for this part we took account of the tax in the cash flows though.
In (ii)(b), we are asked for the "annual effective rate of return earned by the first investor". Since we know that the first investor pays tax on coupons at 25%, the rate of return the investor actually earns will be the net (ie after tax) return.
