To provide full protection against unexpected tax imposition, all Eurobond contracts have a covenant stating that the issuer will increase the interest payments to make up for any tax imposed. Assume that Paf Inc. has issued a Eurobond with a coupon of $10 per $100 bond. For some reason, Paf Inc. is forced by its government to transfer 15% of the coupon as withholding tax, so that the net coupon paid to the bondholder is only $8.50. What should Paf Inc. do, according to the bond covenant?

Question

Quizplus · Accepted Answer

The Answer is The coupon must be increased so that the net receipt by the bondholder is still $10 per $100 bond. Hence, the new coupon rate, r, must verify:

\begin{aligned}10 & = 100 imes r imes ( 1 - 0.15 ) \r & = 11.7647 \%\end{aligned}

To Provide Full Protection Against Unexpected Tax Imposition, All Eurobond