if you have september 2005 at hand, may you enlighten me on this one. question 10 part i ) ,I am confused with the solution given.Why was income tax left in the calculation? If it is a mistake then part ii b) solution is not correct. someone save my soul thanx
September 2005 - Question 10 i) We are told in the question that the market is assuming a gross redemption yield of 5% pa effective. So, since we are using a gross redemption yield (i.e. a yield ignoring tax) to calculate the price of the bond, we must use gross cashflows (i.e. cashflows ignoring tax) when we write down our equation of value. The key point is to ensure that the interest rate used (gross) and the cashflows valued (gross) are consistent. In effect what's happening here is that the investor will purchase the bond in the market and the investor’s personal tax rates will not affect the price paid in the market (where a GRY of 5% is assumed). ii) Here, we are given a net yield to perform our calculations - so for consistency we must use the net cashflows when writing down our equation of value. Hope this helps!
