Bonds, also called fixed-income securities, provide investors with successive in
ID: 2729622 • Letter: B
Question
Bonds, also called fixed-income securities, provide investors with successive income over a specific time frame at regular intervals. These securities are issued by a number of companies, municipalities, and government agencies.
There are unique tax liabilities for investor income derived from bonds and other fixed-income instruments, which affect overall holding period returns realized from these investments. In addition, there are varying levels of risk associated with holding these types of securities.
Select two types of bonds and compare the following between the two types selected:
What are the comparative levels of investment returns for each? View: http://research.stlouisfed.org/publications/usfd/
What are the relevant tax considerations applicable to the investment returns on each?
What are the comparative risk considerations between the two?
Explanation / Answer
Bonds are issued by various corporates and government agencies, as a means of raising money to fund some major financial requirement such as expansion,modernisation of the existing infra-structure or for acquisiton of some fixed asset like land and buildings or machinery.
They provide lumpsum amounts to the issuer ,and also give fixed income at regular intervals for he utilisation of this money by the borrower, and return of the full investment at the specified date.
That fixed income is called interest or return on the amount invested.
Most of the bonds available in the market can be identified as Corporate, Government ,Government Agency or municipal bonds.
Corporate Bonds - These are issued by corporations
Return on Investment - They provide a regular and steady stream of income at a fixed percentage called stated interest.Interest rates are competitive and give good returns.
Tax considerations - The interest income received is taxed in the hands of the receiver, as an ordinary income at the applicable tax rates (both federal and state). If the bonds are sold, for more than the purchase price, the excess is taxed as capital gains.
Risks Involved - There is the credit risk that the issuing company may default before maturity , market fluctuations risk and risk of rising interest rates that may adversely affect bond prices.There is also the risk of bonds being called at the inopportune time for the investor ie. in times of declining interest rates
Municipal bonds- These are issued by various State and Federal agecies/departments of the US government- to raise funds for different projects of public interest.
Return on Investment - They certainly provide regular and steady income at a fixed percentage called stated interest but at lower rates .Interests are more sure than corporate bonds as US government is directly responsible.
Tax considerations - But for some munis or municipal bonds that may be subject to alternate minimum tax ,interest income from most munis are fully tax exempt in the hands of the investor. However,capital gains from sale or reemption is taxable.
Risks Involved - There exists a small amount of credit risk that the issuer may default , before maturity. By and large ,less risky compared to other types of bonds because of the direct sponsorship of the US Government.