Answer:
To calculate the equivalent tax-free rate of a corporate bond, we need to adjust the bond's stated rate by taking into account your marginal tax rate. Here's how we can calculate it:
1. Stated rate on the corporate bond: 5%
This is the rate mentioned on the bond.
2. Marginal tax rate: 10%
Your marginal tax rate represents the portion of your income that you pay in taxes.
To find the equivalent tax-free rate, we need to adjust the bond's stated rate by subtracting the tax savings from the interest earned.
Formula: Equivalent Tax-Free Rate = Stated Rate × (1 - Marginal Tax Rate)
Using the values provided:
Equivalent Tax-Free Rate = 5% × (1 - 10%) = 5% × (1 - 0.1) = 5% × 0.9 = 0.045 = 4.5%
Therefore, the equivalent tax-free rate of the corporate bond is 4.5%, which corresponds to option C.