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%.
Write a memo to your boss that includes the following:
- The after-tax return of the auto ABS is for the client
- A comparison of the pre- and post-tax returns on each bond for the client in either interest rate or dollar terms
- Your recommendation
Right after you sent the memo to your boss, you were given the news that your client has just moved to California and now is subject to a state marginal tax rate of 9.55%. Write a brief e-mail to your boss that explains:
- What the new after-tax return of the auto ABS is for the client as a California resident
- Whether you are revising your recommendation or not and why.