Final answer:
The question relates to determining the taxable equivalent yield of bonds for an investor. It involves understanding bond valuations, coupon rates, and how interest rate fluctuations impact bond prices. A provided example illustrates a yield calculation for a bond purchased below face value.
Step-by-step explanation:
The question is focused on calculating the taxable equivalent yield for an investor based on the tax-free yield of a bond they purchased and their tax bracket. To order the investments from least to greatest return, one would need to know the tax-free yields and the tax brackets of the investor's bonds, to then use the provided formula.As a reference example for understanding bond yields, the scenario given discusses the yield of a $1,000 face value bond with an 8% coupon rate, purchased at $964. The yield is calculated as ($1080 - $964)/$964 = 12%, which combines the interest payments and capital gains, making up the total return.
It's important to note that the yield or total return on a bond is influenced by the market's interest rates. When market interest rates rise, the value of existing bonds with lower interest rates will generally decrease. Conversely, when market interest rates fall, the value of existing bonds with higher coupon rates will likely increase.The taxable equivalent yield of an investment is a way to compare the returns on different types of investments after taking into account the investor's tax bracket. To calculate the taxable equivalent yield, you can use the formula: taxable equivalent yield = tax-free yield / (1 - tax bracket). By plugging in the values provided for each investment and the given tax bracket of 18%, you can determine the taxable equivalent yield for each investment. Once you have calculated the taxable equivalent yields, you can then order the investments from least to greatest return.