SECTION IV: INVESTMENTS

Performance

The yield on a bond is its annual return, which is affected by the price the investor purchased the bond for and the coupon or interest rate on the bond. To compare returns on bonds, compare the yields. Yield to maturity compares bonds based on time, measuring the bond's return when bought and held to maturity. Yield to call expresses the return to the call date, taking into consideration the premium paid for the bond when called and the premium or discount paid for bonds at purchase. For investors purchasing a bond for an income stream, a performance measure that is important to them might be comparing bonds based on the amount of money they will receive each year. This can be determined from each bond's yield to maturity and coupon rate.

When comparing bonds, you can determine the tax-equivalent yield of a tax-free bond using the following formula:

Tax-Equivalent Yield =

Tax-Free Interest Rate (1 - Federal Income Tax Rate)

The formula above helps you calculate and compare the fixed income option that is more tax advantageous. Let's take a moment and walk through an example comparing a choice between a bond with a 4.5 percent tax-free yield and a bond with a 5.0 percent taxable yield. For this example, let's assume a 28 percent federal tax bracket. Using the formula above, here is how to calculate a tax equivalent yield.

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