The dramatic reduction in short-term interest rates and the
dislocation in the bond market have combined to create the
following investment/income tax savings/estate planning
opportunity.
In general, IRS requires that family loans bear interest at an
applicable federal rate ("AFR"). Because AFR's are
based on the rates of U.S. Treasury securities (varying by
duration), the AFR's are at or near unprecedented lows. Thus,
the short-term AFR (i.e., loans of three years or less) for
February is .60%, and the mid-term AFR (loans exceeding three years
but not nine years) is 1.65%.
Many corporate bonds, including investment grade obligations,
are currently selling with yields to maturity of 7%-8%, with
high-yield obligations yielding even more. The spread between
corporate credits and AFR's presents enticing arbitrage and tax
savings opportunities which can be illustrated by the following
example. (For the sake of simplicity, I have ignored transaction
costs and assumed
