Question

A taxable bond has a yield of 10 percent and a municipal bond has a yield of 7 percent. If you are in a 35 percent tax bracket, which bond do you prefer? At what tax rate would you be indifferent between the two bonds? A)6.0%.- after-tax return, 25% - Tax Rate B)7.5%.- after-tax return, 40% - Tax Rate C)6.5%.- after-tax return, 30% - Tax Rate D)7.0%.- after-tax return, 35% - Tax Rate

Answer 1

Step-by-step explanation:

In this scenario, the taxable bond has a yield of 10%, while the municipal bond has a yield of 7%. If you are in a 35% tax bracket, you would prefer the municipal bond because its after-tax return is higher. To determine the tax rate at which you would be indifferent between the two bonds, you need to find the tax equivalent yield. This is the pretax yield that a taxable bond needs to have to match the after-tax yield of a tax-free municipal bond.

Related topics:

Tax Equivalent Yield

Municipal Bonds vs. Taxable Bonds

Tax Bracket