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Bonds - Ranking Investment Opportunities

1. Assume that you are in the 40% federal-plus-state marginal tax bracket and that capital gains taxes are deferred until maturity. Assuming equal investment risk and a horizontal yield curve, rank the following investment opportunities on the basis of the effective annual yields:

a. A $100 par value perpetual preferred stock with an annual coupon of 12%, quarterly payments, and selling at $105.
b. A $1,000 par value, 20-year, non callable, semiannual bond with a coupon of 12% currently selling at $1,050.
c. A $1,000 par value, 20-year, non callable, semiannual bond with a coupon of 6% selling at a price of $637.

d. How would the situation change if the ranker had been:

(1) a pension fund investment manager or
(2) a corporation that is in the 40% federal-plus-state bracket?

Solution Preview

1. Assume that you are in the 40% federal-plus-state marginal tax bracket and that capital gains taxes are deferred until maturity. Assuming equal investment risk and a horizontal yield curve, rank the following investment opportunities on the basis of the effective annual yields:

a. A $100 par value perpetual preferred stock with an annual coupon of 12%, quarterly payments, ...

Solution Summary

Ranking investment opportunities are examined. How situations change if the rankers has been is determined.

$2.19