4) A U.S Treasury Security (which is taxable) has a yield to maturity of 4.0%, w
ID: 2775283 • Letter: 4
Question
4) A U.S Treasury Security (which is taxable) has a yield to maturity of 4.0%, while a Municipal (non-taxable) bond has a yield of 4.6%. The marginal tax rate is 35%.
What is the after-tax yield on each bond?
List two reasons why it is possible for a non-taxable Municipal bond to have a higher before-tax yield than a taxable Treasury Security.
5) On December 31, 2011 the liabilities of ABC Inc. included two bonds. Each bond has a face value of $1,000. Bond 1 has a 10% coupon and will mature on December 31, 2017. Bond 2 is a zero coupon bond that matures on December 31, 2016. The yield to maturity of each bond was 8% on December 31, 2011 and was 10% on December 31, 2012.
What was the price of each bond on December 31, 2011?
What was the duration of each bond on December 31, 2011?
What was the price of each bond on December 31, 2012?
What was the one-year return on each bond if the bond was purchased on December 31, 2011 (immediately after the coupon was paid) and was sold on December 31, 2012 (immediately after the coupon was received)?
Which bond was more “sensitive” to this interest rate change, and why?
Explanation / Answer
4)
After tax yield on the bond is as follows:
=Yield*(1-Tax rate)
=4%*(1-35%)
=2.6%
Reasons why municipal bonds have higher profit than taxable:
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