Question

1) The yield on a corporate bond is 12%, and it is currently selling at par. The marginal tax rate is 20%. A par value municipal bond with a coupon rate of 10% is available. Which security is a better buy?

2) Following are the features of a mortgage loan:

Loan amount $100,000

Nominal interest rate 6.2%

Term – 30 years (Fixed)

Required:

(a) Calculate the required monthly mortgage payment.

(b) Calculate the amount of interest and the repayment of principal amount for the first month.

3) Consider the two bonds as given below:

1. Bond X has 12 years to maturity, a coupon rate of 8% with a part value of $1,000, and the yield-to-maturity of 6%. Calculate the price of the bond.
2. Bond Y has 18 years to maturity, it is a zero-coupon bond with a part value of $1,000. If this bond yields to 8 %, what would the price of this bond be?   

Answer 1

Answer 1 - municipal bond with a coupon rate of 10% is a better buy

Reason -

The equivalent tax free rate for corporate bonds = taxable interest rate *(1 - marginal tax rate)

= 12% ( 1 - 0.2 )

= 9.6%

So, the corporate bonds are offering 9.6% yield whereas the muncipal bonds are offering 10%. So muncipal bonds are a better buy.

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