Explain corporate bond interest in terms of cost of capital versus investor yields. Also, explain the municipal bond interest in terms of investor yields.
Corporate bonds are taxable in the hands of the investor when he receives interest or sells it for profit. On the other hand cost of capital for a firm is the coupon rate paid to the investors after deducting the taxation rate. Ex. A bond issued with a coupon rate of 10%, and tax rate of 30%, has an after tax cost of 10% *(1-30%) =7%. On the other hand the investor yield for the same will be based on his tax rate. If the investor is in a tax bracket of 10%, the investor yield is 10%*(1-10%) = 9%.
In case of municipal bonds, they are tax free for both the issuing entity and the investor. Hence the cost of capital and investor yield will be same i.e. 10% as in our example above.
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