P0: higher coupon stocks offering higher gross redemption yields

Discussion in 'Practice modules' started by FlappyBird, Oct 13, 2015.

  1. FlappyBird

    FlappyBird Member

    Hello all

    On p.14 of unit 1, the notes say pension funds "usually buy high coupon stocks because these offer slightly higher gross redemption yields than lower coupon stocks".

    This is not obvious to me (and I vaguely remember a similar claim in CT2). If the coupons are higher, but time to maturity and redemption value is the same, the difference will be reflected in the price.

    I think the reading's trying to make a subtle point, but it's passing me by. Can anyone help?!

    Thanks
     
  2. Colin McKee

    Colin McKee ActEd Tutor Staff Member

    I am not sure how important it is in the grand scheme of things, but I think what the reading is referring to is this. Bonds are taxed on income only, and capital gains are tax free. If you are a taxed investor, and you buy a low coupon bond, you will buy it at a relatively low price, and it will give you a (tax free) gain to maturity. If you buy a high coupon stock, you get a capital loss to maturity (which is not a "tax loss") and you will get larger amounts of income on which you pay tax. So taxed investors prefer low coupon stocks and drive the prices up. Pension schemes, who don't get taxed on either income or gains, and don't have a preference, will buy the high coupon stocks as they are cheaper.
     

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