Calculations

a. You only pay taxes on realized income, not unrealized income. Your before tax return is:

($1,050 – 1,000 + 40) /1,000 or 9.0%

b. Your after-tax return would include the unrealized capital gains and the interest after you paid taxes. Since this is interest income, it is taxed at your marginal tax rate of 25% (there is no state tax). The after-tax return is:

(1,050 – 1,000 + [40 * (1 - .25)])/1,000 = 8.0%

Of the $40 coupon, you pay $10 in taxes and keep the remaining amount.