Final answer:
To find the after-tax equivalent yield of a municipal bond compared to a corporate bond paying 6.65% interest for an individual in the 25% tax bracket, you calculate the tax-equivalent yield. The municipal bond would need to pay 8.866% to be equivalent, which corresponds to option d.
Step-by-step explanation:
Understanding Municipal Bond Tax-Equivalent Yield
To determine the equivalent after-tax yield of a municipal bond compared to a corporate bond, we use the tax-equivalent yield formula:
Tax-Equivalent Yield = (Corporate Bond Interest Rate) / (1 - Marginal Tax Rate)
In this scenario, the corporate bond pays 6.65% interest and the individual is in a 25% marginal tax bracket. Plugging these values into the formula gives us:
Tax-Equivalent Yield = 6.65% / (1 - 0.25)
Completing the calculation:
Tax-Equivalent Yield = 6.65% / 0.75
Tax-Equivalent Yield = 8.866%
Therefore, the municipal bond would need to pay an after-tax equivalent yield of 8.866% to be equivalent to the corporate bond yielding 6.65% for someone in a 25% marginal tax bracket.
The correct answer to the student's question is option d. 8.866%.