Beth Anaheim is a 70-year-old retiree who has been referred to ACG by a current ACG client. Beth's main investment objectives are safety of principal and current income. Her retirement income sources include social security, rental income from a commercial investment property managed by a professional property management firm, and a $500,000 investment portfolio consisting of several utility company stocks and corporate bonds. Beth is currently in the 30% combined federal and state marginal tax rate. Beth is considering an investment in one of the following bonds:
DES Corporate Bond: A-Rated, 9% coupon rate, maturing in 7 years (recommended by a friend).
FGR Municipal Bond: AAA-rated, 7% coupon, maturing in 7 years (recommended by her ACG investment advisor).
Using the taxable equivalent yield concept, you are to help the ACG advisor explain to Beth why the FGR bond investment could offer a higher yield and lower risk. Make sure that you present the information in as simple a manner as possible without leaving out any pertinent information.© BrainMass Inc. brainmass.com September 23, 2018, 4:19 am ad1c9bdddf - https://brainmass.com/business/bond-valuation/taxable-equivalent-yield-concept-545254
The U.S. tax code states that an individual's income from corporate bond interest (as well as most other interest income) is subject to income taxes. However, the interest that an individual earns on certain bonds issued by state and local governments are not subject to federal income taxes. Likewise, most states tax the interest from most financial instruments, generally excluding only bonds issued by their state or by local governments within their state. In this case the DES corporate bond earns a 9 percent return, but that return is subject to both federal and state income taxes. By contrast, ...
This solution illustrates how to determine the equivalent yield of a tax-free bond to a taxable bond.