Some aspects of the tax status of a return from a bond may cause the yield to maturity to be an inaccurate measure of an investor's return from owning the bond. Suppose that Bob owns a bond that was issued nine years ago and has one year left to maturity.
The bond has a yield to maturity of 7%, with a current yield of 3% and an expected capital gain of 4%. Suppose that Juanita owns a bond that is a newly issued oneyear bond with a yield to maturity of 8%.
If you are an investor with a 33% tax rate on interest income but a 0% tax rate on capital gains, which bond would you prefer to own? Briefly explain.