Sally Is Choosing Between Two Bonds Both of Which Mature

question 24

Multiple Choice

Sally is choosing between two bonds both of which mature in 15 years and have the same level of risk. Bond A is a municipal bond that yields 5.25%. Bond B is a corporate bond that yields 7.75%. If Sally is in the 30% tax bracket, which bond should she select and why?

• A) Sally should select Bond A because its interest income is not taxable.
• B) Sally should select Bond B is better because it has lower risk.
• C) Sally should select Bond A because its taxable equivalent yield is greater than the yield of Bond B.
• D) Sally should select Bond B because the taxable equivalent yield of Bond A is less than the yield of Bond B.

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Definitions:

Normal Balance

the side (debit or credit) on which increases to an account are recorded, based on the type of account (asset, liability, equity, revenue, or expense).

Contra-Asset

An account that offsets or reduces the balance of a related asset account, such as accumulated depreciation.

Allowance for Doubtful Accounts

An estimation recorded on financial statements reflecting the amounts expected to be uncollected from accounts receivable.