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Calculation of Tax Effective Yields for Discount Instruments

Published online by Cambridge University Press:  19 October 2009

J. W. Colin  and
Richard J. Bayer
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Extract

This paper proposes a model that a dealer or investor may employ in determining

• The potential investment value of a debt instrument,

• The potential gains in net after-tax yield which result from swaps, and

• The trade-off, effective, after-tax yield on a municipal vs a taxable corporate bond of the same quality or rating.

Type
Communications
Information
Journal of Financial and Quantitative Analysis , Volume 5 , Issue 2 , June 1970 , pp. 265 - 273
Copyright
Copyright © School of Business Administration, University of Washington 1970

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References

page 265 note 1 The system developed by the authors is currently employed by First National Bank of Dallas.

page 266 note 2 The conversion is done using Financial Net Yield Table After 25 Percent Capital Gains Tax for Tax-Exempt Discount Bonds, Financial Publishing Company.

page 266 note 3 (25%) + (5% × 25%) = 26.25%.

page 266 note 4 .MTR currently equals zero for municipal bonds.

page 267 note 5 Financial Compound Interest and Annuity Tables, 4th ed., Financial Publishing Company, 1966.Google Scholar

(a) Tables are by increments of¼ 1/4 percent through 7– ¾ percent.

(b) Increments are by ½ percent through 9-½ percent, thereafter by 1 percent increments through 25 percent.

page 267 note 6 In month, day, and year format.

page 268 note 7 The computer program employed performs day interpolation using method C, page 2, of the “Recommendations for Computation of Principal and Interest on Transactions in Municipal Securities,” approved November 30, 1961, by the IBA.

page 271 note 1 Interest and Annuity Tables, op. cit.

page 271 note 2 For tax-exempt securities with MTR=0, set i = i* + 0.005.

page 271 note 3 Stop the process at the first “oscillation,” i.e., a situation where steps 5 and/or 6 return you to previously employed interest rates for i and i*. proceed to step 7.

page 271 note 4 Although this is not the “optimum” search criterion, it insures that the interest rates used in manual interpolation will be found in standard tables, thereby reducing reliance on a desk calculator to calculate the single payment or series present worth factors and speeding up the calculations. The computer program employs a Fibonacci type search criteria and will, in general, iterate to a solution in five trials.

page 272 note 5 For tax-exempt securities with MTR=0, set i* = i minus;0.005.