Kevin J. Maloney

Simplifying Tax Simplification: An Analysis of Its Impact on the Profitability of Capital Investment

* Tax simplification and reform is a concept that is very much a part of the current political climate in the United States. There are currently three tax simplification plans now receiving significant attention in Washington: the Fair Tax Plan sponsored by Senator Bill Bradley and Representative Richard Gephardt, the FAST Tax Plan sponsored by Representative Jack Kemp and Senator Robert Kastens, and the Tax Simplification Plan proposed by the Treasury Department. Three common themes pervade each of these plans. They are that the number of tax brackets should be reduced, marginal tax rates should be lowered on individual and corporate income, and the tax base at both the individual and the corporate level should be broadened. The authors of the plans argue that these changes would make the individual and the corporate income tax systems more equitable and more efficient. While the passage of a full-scale tax reform bill by Congress is by no means certain, it is probably a safe bet that many of the base broadening provisions for the

Evaluating the Decision to Issue Original Issue Discount Bonds: Term Structure and Tax Effects

* There is considerable evidence that during periods of high interest rates participants in the financial markets rely more heavily on innovative financing methods. In an attempt to deal with the high interest rates of recent years, corporate borrowers have devised a series of special characteristics for corporate bond issues including put options, detachable warrants, and variable coupon rates.2 Certainly one of the more important innovations employed by corporate borrowers has been the original issue discount bond (OID).3 The OID has recently been the subject of a considerable amount of academic research. Most notably, studies by Kalotay [61 and Pyle [8] have documented many

An equilibrium debt option pricing model in discrete time

Abstract In this paper we develop a discrete time binomial model for pricing options on default free debt securities. The model is a single factor or spot rate model in which an arbitrage free term structure is developed and used to price any interest rate contingent claim. The model differs from other work in this area in that the model is straightforward to program and use, and is not bound by a restrictive equilibrium concept such as the expectations hypothesis. The paper demonstrates various properties of the model and demonstrates how information from the existing term structure can be used to parameterize the model.

The term structure and callable bond yield spreads

T he inclusion of call provisions on various types of bonds is widespread. Virtually all corporate bonds and many government bonds contain call features. Since these features are commonplace, both buyers and sellers of bonds must be concerned with the effect of callability on prices and yields. In addition, issuers of callable bonds must be concerned with the optimal design of the call feature, such as call price and length of call protection, and with whether it is optimal to exercise the call option at a particular moment or to delay the decision. These two issues, discussed elsewhere,’ ‘are not the subject of this paper. Here we consider only those factors that determine the value of the call provision and, hence, the yield spread between otherwise identical callable and non-callable securities. The conventional wisdom regarding the value of a call option is summarized well by Van Horne (1978). It is generally believed that the level of interest rates exerts a positive effect on the compensation in yield required for investors to be indifferent between otherwise identical callable and non-callable bonds. In particular, the higher the general level of interest rates, the higher (lower) is the price (yield) on a non-callable bond relative to an identical callable bond. The intuition underlying this approach is based upon the assumed relationship between the level of interest rates and investors’ expectations about future interest rates. When rates are historically high, so the argument goes, there is a greater probability that rates will fall in the future, at which time the issuer of the callable bond will find it beneficial to exercise the op-