Exam (elaborations)
BUS 5111 Unit 4 Discussion Assignment
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A guide to assignment on Corporate bond interest in terms of Cost of capital versus Investor yield
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Explain corporate bond interest in terms of cost of capital versus investor yields. Also,explain the municipal bond interest in terms of investor yields
A corporate bond is one form of debt security that an organization issue and sells to investors
(Chen, 2020). Companies get the capital they require for expansion or investment and the
investor gets a predetermined return through installment with a fixed or variable interest. These
payments will continue until the bond expires or "reaches maturity", then the initial investment is
returned.
The cost of capital is a rate of interest that may be fixed or variable that is set when issuing the
bond. We can look at cost of capital from the company's (borrower) side and the investor's
(lender) point of view. From the company's side, it is a cumulative rate of interest (commonly a
weighted average of all interests) applied to borrowed capital to fund an investment
(lumenlearning, 2021). From the investor's perspective, the cost of capital is the rate of return
required to cover the risk of an investment and earn a profit.
As explained above, companies source capital through debt, and one of the common ways is
using corporate bonds. Corporate bond interest is low because it carries relatively lower risk as
an investment; consequently, it has a lower return rate. One of the reasons is that in case of
bankruptcy, debts are paid back first.
Bonds have ratings that indicate their quality and stability. Hence, these ratings will affect the
interest rate, investors' interest, and bond pricing. The higher the interest on corporate bonds
signifies the higher value we regard its cost of capital and in turn a higher expected yield in
investment. If an investor wants to get a higher yield, then the risks will be higher but the
investment is believed to provide higher profit.
Municipal bonds ("munis" for short) are debt securities that are issued by governmental entities
like cities or states to finance capital projects or day-to-day obligations (Lioudis, 2021). The
maturity period for these bonds could range from a year to a decade. Commonly, the interest on
municipal bonds is exempted from federal income tax (Howard & Martin, 2021).
As mentioned above, munis are generally exempt from federal and even state income taxes and
aren't subject to the 3.8% tax on high earners’ investment income (Howard & Martin, 2021).
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