Problem: As a financial adviser to individual investors, your boss has asked you to write a memo to him analyzing a choice of two bonds for a client seeking to invest $350,000. The Florida-based client has a relatively high taxable income, and while she has an affinity for municipal bonds, she is looking for interesting fixed income alternatives. In your meeting with your boss you took notes on the two bonds the client is considering. One is a 10-year, AA rated municipal bond issued by the City of Boston with a 3.875% coupon, and the other is the senior tranche of an auto ABS, also with a 10-year maturity and a 6.875% coupon. The client has a Federal marginal tax rate of 35%.
Q1. What is the after-tax return of the auto ABS is for the client?
Q2. Compare the pre- and post-tax returns on each bond for the client in either interest rate or dollar terms.
Q3. What bond would be the better choice?
Q4. If my client moves to California and now is subject to a state marginal tax rate of 9.55%. what would happen to the following:
Q5. What the new after-tax return of the auto ABS is for the client as a California resident
Q6. Would you still select the same bond above?