Archive for April, 2007
Corporate Bonds Baa
April 25th, 2007
Question: The Risk Structure of Interest Rates?
I would really appreciate it. Thank you!!
The risk structure of interest rates studies the behavior of interest rates for bonds with the same term to maturity but different risk characteristics. Which of the following combinations of bonds provides the best situation to study the risk structure of interest rates?
A. A three-month Treasury bill vs. a 30-year Treasury bond
B. A 30-year Treasury bond vs. a corporate Aaa bond
C. A six-month Treasury bill vs. a corporate Aaa bond
D. Six-month commercial paper vs. a seven-year Treasury note
E. Three-month commercial paper vs. a corporate Baa bond
Answer: The best combination to observe the risk structure is option B: a 30 year Treasury bond and a corporate Aaa bond. The reason for this is simple. A 30 year Treasury bond and a corporate Aaa bond have similar terms so the term structure is constant, therefore, the primary difference is the risk structure. To further explain this answer I'll eliminate the other options.
Option A does not work because they are the same type of security--government securities--so they have the same risk (which, by the way, is virtually zero).
Option C does not work because those bonds of vastly different terms--6 months vs. about 30 years
Option D does not work because those bonds are also of vastly different terms--6 months vs. 7 years
Option E does not work because they are both vastly different terms and they are the same type of security--corporate debt
Therefore, Option B is the correct choice because it compares different types of securities (government vs. corporate) of similar terms (about 30 years).
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Corporate Bonds Capital Gains Tax
April 7th, 2007
Question: Taxes on ROTH IRA vs. 401(K)?
Can someone please explain this quote:
"For example, profits from stocks that are held for at least a year will be taxed as long-term capital gains -- a rate no higher than 15%. Interest from Corporate Bonds, on the other hand, is taxed as ordinary income -- a rate as high as 35%. Yet many investors keep their stock investments in their tax-advantaged accounts and their bonds in regular, taxable accounts. That just doesn't make sense. Asset location can be just as important as asset allocation." http://finance.yahoo.com/focus-retirement/article/104396/Nine-Retirement-Killers?mod=retirement-preparation
I thought the advantage of a ROTH IRA (which is what I'm invested in now -- 100% stocks) was the fact that you are putting in post tax money that won't be taxed when you retire. But say I'm in the 28% tax bracket now, wouldn't it make more sense for me to put the money into an account that taxes later, if it's only going to tax my interest by 15%??? Am I totally confused?
Answer: It depends on how you will be living when you retire. It's also no guarantee the tax rates now won't be higher 20-30 years from now. I would max out my 401K especially if there is an employer match. I would also max out my Roth. There is no right or wrong way. It just depends on how much income you plan on having in retirement, you need to plan accordingly. I would always opt for the Roth because just like I said it's no guarantee with the future tax rates.
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