Question

You can invest in taxable bonds that are paying a yield of 9.1 percent or a municipal bond paying a yield of 7.35 percent. Assume your marginal tax rate is 21 percent. a. Calculate the after-tax rate of return on the taxable bond? (Round your percentage answers to 2 decimal places. (e.g., 32.16)) b. Which security bond should you buy?

Answer 1

The after-tax rate of return on a taxable bond is calculated by multiplying the pre-tax yield by one minus the tax rate. In this case, it would be 9.1% x (1 - 0.21) = 7.19%. The municipal bond is tax-free, so its after-tax rate of return is equal to its pre-tax yield of 7.35%. Therefore, you should buy the municipal bond as it has a higher after-tax rate of return than the taxable bond.