Question

• compare in details  the coupon rate and the interest rate regarding bonds, with examples
• What is a par value?
• Describe the impact of a tax shield on fixed income yields and the bonds with real examples and references

Answer 1

A coupon rate is the period amount the issuer will pay on the bonds face value or par value. Par value/face value is the value of the bond at which the issuer will redeem the bond at the time of maturity. Coupon rate as a percentage of the face value and are either paid annually or sem annualy. For example if coupon rate of 5% on a face value of 1000$ means the issuer has to pay 50$ to the customer annualy.

Coupon rate is different from interest rate. For example if the bonds face value is 1000 with a coupon rate of 10% and you bought the bond at 1500; your coupon rate still will be 100 ; whereas your interest rate will be 100/1500 =6.6%

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Impact of tax shield on fixed income yields:

A tax shield is a reduction in taxable income of a company/individual due to the debt instruments like loans or bonds. There are many bonds in the market which offers tax benefits. ie the net tax that to be paid through the earnings of such bonds are tax deductible. For example; Th e effective yield on fixed income yields will considerable increase if we invest in such debt instruments. For example; a bond with tax benefits and a coupon of 5% and a general tax of 30% will have an effective yield by the below equation

Effective yield = coupon rate/ (1-tax rate). Hence, for a coupon of 5%, the investor has an effective yield of 7.14%. The higher yield is only due to the tax benefits. Change in tax rate will directly affect the effective yield on the debt instruments.