Question

Harry Swartz wants to invest in a bond and has narrowed his choices down to two issues. The first is offered by Microsoft Corp. and pays an interest rate of 8%. The second option is offered by the city of Springfield, Massachusetts, and offers a return of 6%. Harry feels that the risk levels inherent in the two bonds are similar. They both mature in 10 years. Harry is single, has taxable income of $125,000 in 2009 and lives in a state that has no personal income tax. Which bond should Harry choose?

Answer 1

Harry should choose the bond offered by Microsoft Corp because it pays a higher interest rate of 8% compared to that of a similar risk bond which pays a lower interest rate of 6%. The higher the interest rate the lower will be the price of the bond. So, Harry is paying a lower price for the bond compared to that of a risky bond.

There is no maturity risk difference between both the bonds as they both mature in 10 years.

The income tax is of no consideration as Harry lives in a state where there is no personal income tax.