Question: Theodora lives in Albania and works as a data architect at a major bank. Since she is paid more than L140,000 (Albanian lek) each month, and there are three tax brackets in the country, she falls in the 23% tax bracket. (The other tax brackets are 0% for incomes up to L30,000 and 13% for incomes between L30,000 and L140,000.) Capital gains and interest income are taxed at 15% regardless of the holding period and the taxable bracket which she belongs to. Two years ago, she invested L500,000 in a five-year government bond with a 6.4% coupon. She bought the bond for 100% of par value two years ago. One year ago, it was revalued at 101%, and now it has been revalued at 103% in the market.
a. Calculate the pretax and after-tax HPR of the bond investment for each year. (Assume that Theodora bought and sold the bond at the beginning and end of each year.)
b. Calculate the average after-tax HPR over the two-year period.
c. Assume that next year the government will change the treatment of capital gains and interest income, instead considering them as ordinary income, and Theodora has no source of income other than her salary. How would this affect her taxable income in the next year if the bond was sold at 104% of market value?