商业银行管理Chap010.pptVIP

Factors Affecting Choice of Investment Securities (continued) Tax Exposure To evaluate the attractiveness of municipals, financial firms calculate the net after-tax returns and/or the tax-equivalent yields to enable comparisons with other investment alternatives The net after-tax return of bank-qualified municipals is calculated as Factors Affecting Choice of Investment Securities (continued) Tax Exposure The tax advantage of a qualified bond is determined as Factors Affecting Choice of Investment Securities (continued) Tax Exposure Suppose a bank purchases a bank-qualified bond from a small city, county, or school district and the bond carries a nominal gross rate of return of 7 percent The bank had to borrow the funds needed to make this purchase at an interest rate of 6.5 percent and is in the 35 percent tax bracket The bond’s net annual after-tax return (after all funding costs and taxes) must be: Factors Affecting Choice of Investment Securities (continued) Tax Exposure In years when loan revenues are high, it may be beneficial to engage in tax swapping In a tax swap, the lending institution sells lower-yielding securities at a loss in order to reduce its current taxable income, while simultaneously purchasing new higher-yielding securities in order to boost future returns Lending institutions also do a great deal of portfolio shifting in their holdings of investment securities, with both taxes and higher returns in mind Factors Affecting Choice of Investment Securities (continued) Interest Rate Risk Rising interest rates lowers the value of previously issued bonds Longest –term bonds suffer the greatest Losses Many interest rate risk tools including futures, options, and swaps exist today Factors Affecting Choice of Investment Securities (continued) Credit or Default Risk The risk that the security issuer may default on the principal or interest owed Three major credit ratings agencies Moody’s Standard Poor’s Fitch’s Rating Service TABLE 10–4