Optimal Tax Management of Municipal Bonds

Tax considerations play an important role in the management of taxable portfolios. In a wellknown paper Constantinides and Ingersoll (1984) discuss the applicability of tax management to bonds in general. Tax-exempt municipal bonds are particularly suitable because they are primarily held in taxable accounts. While the interest is tax-exempt, capital gains and losses are subject to complex tax treatment. Empirical research of secondary market trades by Ang et al. (2010) indicates that the marginal investors in tax-exempt bonds are in the highest tax bracket, and recent articles in trade publications confirm this finding (Bond Buyer, July 3 and July 8, 2013). The right to make a tax-driven trade is an option; we will refer to it as the embedded ‘tax option’ of a bond. 1 Undoubtedly the best-known tax management strategy is selling a bond whose value has declined, i.e. selling a loser (colloquially referred to as tax-loss harvesting). Sequential investors can exercise this option over the life of the bond — when warranted the original holder sells the bond, the new holder acts likewise, and so on. The paper (Kalotay and Howard, 2014) describes an algorithm for optimum tax loss harvesting, and determines the value of the tax option at the time of issuance. The results indicate that the value of the tax-option of

A Framework for Corporate Treasury Performance Measurement

Corporations generally do not have a formal process for evaluating the effectiveness of their treasury departments in managing debt. To the extent that corporate borrowing decisions are predicated on "market timing" rather than matching the interest rate sensitivity of the firm's liabilities to that of its assets, the firm is effectively making bets on interest rates that should be monitored and evaluated. 2005 Morgan Stanley.

Callable Bonds: Better Value Than Advertised?

Callable bonds allow issuers to manage interest rate risk in the sense that if rates decline, the bonds can be redeemed and replaced with lower-cost debt. Investors demand a coupon premium for giving issuers this option; and when deciding whether to issue callable or noncall-able bonds, the issuing companies must determine whether it's worth paying the coupon premium. Copyright (c) 2008 Morgan Stanley.