Financial planning cases 14-4 An Aggressive Investor Seeks Rewards in the Bond Market

Jessica Varcoe works as a drug manufacturers representative based in Irvine, California. She has an aggressive investment philosophy and believes that interest rates on new bonds will drop over the next year or two because of an expected economic slowdown. Jessica, who is in the 25 percent marginal tax rate, wants to profit in the bond market by buying and selling during the next several months. She has asked your advice on how to invest her $18,000.

1. If Jessica buys corporate or municipal bonds, what rating should her selections have? Why? (Hint: See Table 14-6.)

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2. Jessica has a choice between two $1,000 bonds: a corporate bond with a coupon rate of 5.1 percent and a municipal bond with a coupon rate of 3.2 percent. Which bond provides the better after-tax return? (Hint: See Equation [4.1].)

   -Select-Corporate bondMunicipal bondItem 2

3. If Jessica buys eighteen 30-year, $1,000 corporate bonds with a 5.1 percent coupon rate for $940 each, what is her current yield? Round your answer to two decimal places. (Hint: See Equation [14.4].)

   %

4. If market interest rates for comparable semiannual corporate bonds drop 1 percent over the next 12 months (from 5.1 percent to 4.1 percent), what will be the approximate selling price of Jessica's corporate bonds in (c)? (Hint: Use Formula 14.3 or the Garman/Forgue companion website.) Round PVIFA and PVIF values to four decimal places. Round your answer to the nearest cent.

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5. Assuming market interest rates drop 1 percent in 12 months, how much is Jessica's capital gain on the $18,000 investment if she sells? (Ignore transaction costs.) Round your answer to the nearest dollar.

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   How much was her current return for the two semiannual interest payments? Round your answer to the nearest dollar.

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   How much was her total return, both in dollars and as an annual yield? Round your answer for total return in dollars to the nearest dollar and answer for total return as an annual yield to two decimal places.

   $ or %

6. If Jessica is wrong in her projections and interest rates go up 1 percent over the year, what would be the probable selling price of her semiannual corporate bonds? (Hint: Use Formula 14.3 or the Garman/Forgue companion website.) Round PVIFA and PVIF values to four decimal places. Round your answer to the nearest cent.

   $

   Explain why you would advise her to sell or not to sell.

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