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Assume Mr. Davis can buy either a $10,000 corporate bond yielding 10% or a municipal bond yielding 7%. Assume risk is constant. Assume also that his Federal tax rate will be 28% and his State tax rate 7% and that the municipal bond is exempt from both types of income taxes.

Which should he buy, if the yield and tax consequences are the only variables

A bond has the following terms:

(When asked for a % yield, round yields to nearest tenth of a percent, such as 10.1 %.)

1. What is the bond’s price if comparable debt yields 12%?
2. What would be the price if comparable debt yields 12% and the bond matures after 5 years?
3. What are the current yields and yields to maturity if a. and b.?
4. What would be the bond’s price in a. if interest rates declined to 8%? What if the bond matures after 5 years?
5. What are the current yields and yields to maturity in d.?
6. What two generalizations may be drawn from the above price changes?

You purchase a high-yield, junk bond for $1,000 that pays $140 annually. After buying the bond, yields decline and you are able to reinvest the interest at only 9 percent. You reinvest all the interest payments.

How much will you have when the bond is retired after 12 years? What was the annual return you earned on this investment?

Determine the current market prices of the following $1,000 bonds if the comparable rate is 10% and answer the questions.

• • XY 5 percent, with interest paid annually for 20 years.
  • AB 14 percent, with interest paid annually for 20 years.

1. Which bond has a current yield that exceeds the yield to maturity?
2. Which bond may you expect to be called? Why?
3. If CD, Inc. has a bond with a 5 percent coupon and a maturity of 20 years but which was lower rated, what would be its price relative to the XY, Inc. bond? Explain