Question

What rate would a taxable corporate bond have to pay to be comparable to a municipal bond with a coupon rate of 7 percent if the investor is in the 28 percent tax bracket?

Answer 1

An investor in the 28 percent tax bracket would need a corporate bond rate of approximately 9.72 percent to be comparable to a municipal bond with a 7 percent coupon rate, since municipal bonds are generally tax-exempt and offer lower rates.

Step-by-step explanation:

The subject of the question is determining the equivalent corporate bond rate needed to match the after-tax yield of a municipal bond. Since interest from municipal bonds is generally exempt from federal taxes, they typically offer lower interest rates. However, to an investor in a tax bracket, the effective after-tax yield can be competitive with higher-yield taxable bonds.

To calculate the comparable corporate bond rate for an investor in the 28 percent tax bracket with a municipal bond yielding 7 percent, we can use the following formula:

Equivalent Taxable Rate = Municipal Bond Rate / (1 - Tax Rate)

Equivalent Taxable Rate = 0.07 / (1 - 0.28) = 0.07 / 0.72 ≈ 9.72%

An investor in the 28 percent tax bracket would need to find a corporate bond paying approximately 9.72 percent to achieve a comparable after-tax yield to a municipal bond with a 7 percent coupon rate.