Question

discuss corporate bond interest in terms of cost of capital versus investor yields. Also, discuss municipal bond interest in terms of investor yields.

Answer 1

We know that there are two parties of corporate bond, one is issuer party that is known a company which issues these corporate bonds and second party is buyer of the bonds (investors). So there will be two terms that are cost of capital and yields. So let’s understand both one by one. Cost of capital is the amount of interest paid by the company to bond holders. As company uses the funds raised through issue of bonds that is why there will be a regular payment of interest to the bond holders, this regular payment of interest is a cost of capital. Cost of capital is a burden on the income of the company and this cost of capital is deducted from revenues from the company and remaining amount is taxed with effective tax rates.

On other hand second party which is known as investor receives regular payments from the company on invested amount this regular return is known as yield to the investors. As we know that investors can earn yield and gains on the sale of these corporate bonds. So investors need to pay taxes on income received from company on the invested amount.

So for company interest paid on corporate bonds is known as cost of capital because this is a cost for the company for using raised funds whereas for investors received amount is known as yield.

We know that municipal bonds are issued by the government bodies such as central government, state government and local authorities. So buyers of these bonds will receive regular payment on these municipal bonds which is known as yield on these bonds. This yield on these bonds are tax free income for the investors that is why municipal bondholders do not need to pay taxes on yield of municipal bonds.