a)The coupon savings on Build America Bonds (BAB) comes from the initial function of the Bonds, on average, 84 basis points on interest costs for 30-year bonds and also received significant savings on shorter maturities, as compared to traditional tax-exempt bonds. While, in this case, the State of Maine issue BABs, and the Treasury provides a 35 percent direct subsidy to State of Maine to offset its borrowing costs.
b)The purpose of Build America Bonds is to reduce the cost of borrowing for state and local government issuers and Government Agencies. The subsidy, as a response to the recession, was designed to save issuers more than the implicit subsidy associated with traditional tax-exempt bonds. Second, the bonds have appealed to a broader set of investors, including pension funds and sovereign wealth funds.
c)An investor would like to purchase a Build America Bond, whose interest rates are partially subsidized by the U.S. Government (the right bonds presented on the graph).
This can help diversify a portfolio with bonds that have the security of 35 percent of the interest being paid (tax credit) by the federal government, and are considered more secure than conventional municipal bonds (the left bonds presented in graph).
3.742 %*( 1-35%)=2.4323% ,which is the actual yield for the BAB, though it coupon rate 2.4323%
