Question

1. You are a financial analyst for an intenational firm that deals in bonds. There are two bonds been offered: ADANSI EAST bond and ENERGY bond. ADANSI EAST is a tax free bond and ENERGY is taxable bond. The firm is interested in buying one of the bonds and you are being asked to explain the impact of tax free and tax statuses of the bonds on the price and interest rates of the two bonds using appropriate graphs.

Answer 1

Bonds which are tax free nature will always be offering with the lower Yield because those ones are always providing the investors an extra feature of not getting taxed so it will compensate it with a lower rate of interest on those bond.

Bonds which are getting taxed will be trying to offer higher rate of interest in order to compensate for the taxation but it is often known that the tax component on the interest is always tax deductible in nature.

The interest which are payable on these debt are supposed to be tax deductible in nature because there is a provision for providing with income Tax shield so all those interest payments are always provided with tax deduction and it will not matter much for company which is looking for the long run and these companies will be trying to go for bonds which are generally taxable in nature, because it will provide this company with the tax deduction and when there is a higher taxation regime, it will provide them with more deduction.

So it is always dependent upon the risk tolerance and and risk appetite of various companies in order to invest in various bonds according to their taxability.