Question

You can invest in taxable bonds that are paying a yield of 8.9 percent or a municipal bond paying a yield of 7.15 percent. Assume your marginal tax rate is 21 percent. Which security should you buy

Answer 1

We should invest in municipal bond to have profit.

Step-by-step explanation:

• taxable bonds: 8.9 percent
• municipal bond: 7.15 percent
• marginal tax rate: 21 percent.

So we need to identify the after-tax or equivalent tax exempt yield on the taxable bond:

8.9% ( 1 - 21%)

= 0.089*0.79

= 0.0703 = 7.03%

and it is smaller than the yield of municipal bond (7.15%) so we should invest in municipal bond to have profit.