An Investor Is Comparing the Following Two Bonds: a Bond

question 87

Multiple Choice

An investor is comparing the following two bonds: a bond from ABC Corp which pays an interest rate of 9 percent per year and a municipal bond which pays an interest rate of 7.9 percent per year.The investor is in the 15 percent tax bracket.Which bond will give the investor a higher after-tax interest rate and for which reason?

• A)The ABC bond because it pays a 9 percent interest rate,while the municipal bond only pays 7.9 percent .
• B)The ABC bond because it pays an equivalent after-tax rate of 10.6 percent,while the municipal bond pays out an equivalent after-tax rate of 9.3 percent.
• C)The municipal bond because it pays an equivalent after-tax rate of 9.3 percent,while the ABC bond pays out a 9 percent interest rate.
• D)The municipal bond because it pays an equivalent after-tax rate of 7.9 percent,while the ABC bond pays out an equivalent after-tax rate of 10.6 percent.
• E)None of the above is correct.

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Definitions:

Adjusting Entries

Entries necessary at the end of the accounting period to measure all revenues and expenses of that period and update assets and liabilities.

Effective-Interest Method

A technique used in accounting to amortize the discount or premium on bonds payable over the life of the bonds more accurately than the straight-line method.

Bonds

Bonds are fixed-income securities that represent a loan made by an investor to a borrower, typically corporate or governmental, which pays periodic interest payments and the return of the principal at maturity.

Amortization

The gradual reduction of a debt or the spreading out of capital expenses for intangible assets over a specific period of time.