Question

A municipal bond yields 9%, and a similar maturity corporate bond yields 12%. Which investment is better for an investor with a 30% tax bracket?

a) Municipal bond
b) Corporate bond
c) Both are equally beneficial
d) Cannot be determined

Answer 1

For an investor in the 30% tax bracket, a municipal bond yielding 9% is better than a corporate bond yielding 12% due to the tax-exempt status of municipal bonds, which results in a higher after-tax yield.

Step-by-step explanation:

Assessing which investment is better for an investor in a 30% tax bracket—the municipal bond yielding 9% or the corporate bond yielding 12%—we need to consider the after-tax yield. Since interest on municipal bonds is often exempt from federal taxes, the full 9% yield can be retained by an investor. However, for a corporate bond yielding 12%, the after-tax yield would be only 8.4% after accounting for the 30% tax rate (12% * (1 - 0.30)). Therefore, the municipal bond offers a higher after-tax yield for an investor in the 30% tax bracket, making option (a) the better investment.