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 a minuscule 1 percent in a money market account; thus they are seeking greater yields with bond investments. Examine the table located below, 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 todays issues.

What is the current yield of each investment alternative? Use Equation (14.4) or visit the Garman/Forgue companion website. (Write your responses in the proper column in the table.) Round your answers to one decimal place.

What is the yield to maturity for each investment alternative? You may calculate the YTMs by using Equation (14.5) or by visiting the Garman/Forgue companion website. (Write your responses in the proper column in the table.) Round your answers to one decimal place. Enter negative values with minus sign.

Name of IssueBond DenominationCoupon Rate PercentYears Until MaturityMoody's RatingMarket PriceCurrent YieldYTMCorporate ABC$1,0005.34 Aa$1,400 % %Corporate DEF$1,0005.920 Aa$1,450 % %Corporate GHI$1,0006.312 Baa$1,200 % %Corporate JKL$1,0004.85 Aaa$1,500 % %Corporate MNO$1,0004.515 B$1,300 % %Corporate PQR$1,0002.611 B$1,150 % %Treasury note$1,0002.63 -$1,500 % %Municipal bond$1,0002.320 Aa$1,250 % %

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

-Select-Corporate ABCCorporate DEFCorporate GHICorporate JKLCorporate MNOCorporate PQRItem 17

Why?

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Given that the Johnsons are in the 25 percent federal marginal tax rate, what is the equivalent taxable yield for the municipal bond choice? You may calculate the equivalent taxable yield using the provided information. Use the yield value obtained in part b. Round your answer to one decimal place.

%

Should they invest in your recommendation in part (c) or in the municipal bond?

-Select-Corporate ABCCorporate DEFCorporate GHICorporate JKLCorporate MNOCorporate PQRMunicipal bondItem 20

Why?

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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?

-Select-Corporate ABC and Corporate GHI and Municipal bondCorporate DEF and Corporate GHI and Municipal bondCorporate JKL and Corporate MNO and Municipal bondCorporate ABC and Corporate JKL and Municipal bondCorporate JKL and Corporate PQR and Municipal bondItem 22

Why do you suggest that combination?

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