Chapter $14$ Investing in Stocks and Bonds

$485$

Financial Planning Cases

Case $1$

The Johnsons Want Greater Yields on

Investments

The investments of Harry and Belinda have done well through the years. While the cash portion of their portfolio has risen to $$16,000,$ it is earning only $1$ percent in a money market account; thus they

are seeking greater yields with bond investments. Examine the following table, which identifies eight investment alternatives, and then respond to the questions that follow. The coupon rates vary because the issue dates range widely, and market prices are above par because older bonds paid higher interest than today's issues.

$\backslash$table$[[$Name of Issue,$\backslash$table$[[$Bond$],[$Denomination$]],\backslash$table$[[$Coupon Rate$],[$Percent$]],\backslash$table$[[$Years Until$],[$Maturity$]],\backslash$table$[[$Moody$\text{'}$s$],[$Rating$]],\backslash$table$[[$Market$],[$Price$]],\backslash$table$[[$Current$],[$Yield$]]],[$Corporate ABC,$$1,000,5\mathrm{.}4,4,$Ya$,$$$1,400,],[$Corporate DEF,$1,000,5\mathrm{.}5,20,$Aa$,1,550,],[$Corporate GHI,$1,000,5\mathrm{.}9,12,$Baa,$1,250,],[$Corporate JKL$,1,000,4\mathrm{.}8,5,$Aaa,$1,500,],[$Corporate MNO,$1,000,4\mathrm{.}1,15,$B$,1,260,],[$Corporate PQR$,1,000,5\mathrm{.}3,11,$B$,1,200,],[$Treasury note,$1,000,2\mathrm{.}2,3,-,1,600,],[$Municipal bond,$1,000,2\mathrm{.}1,2n,$Aa$,1,200,]]$

$($a$)$ What is the current yield of each investment alternative? Use Equation $(14\mathrm{.}4)$ and complete the column in the table.

$($b$)$ What is the yield to maturity for each investment alternative? Calculate the YTMs by using Equation $(14\mathrm{.}5).$

$($c$)$ Knowing that the Johnsons follow a moderate investment philosophy, which one of the six corporate bonds would you recommend? Why?

$($d$)$ Given that the Johnsons are in the $25$ percent combined federal and state marginal tax rate, what is the equivalent taxable yield for the municipal bond choice? Should they invest in your recommendation in part $($c$)$ or in the municipal bond? Why?

$($e$)$ Which three of the eight alternatives would you recommend as a group so that the Johnsons would have some diversification protection for their $$16,000?$ Why do you suggest that combination?