Question

An investor purchases one municipal bond and one corporate bond that pay rates of return of 7% and 8.4%, respectively. If the investor is in the 15% tax bracket, his after-tax rates of return on the municipal and corporate bonds would be, respectively, _____.

Answer 1

• After-Tax return on Municipal Bond = 7%
• After-Tax Return on Corporate Bond = 6.72%

Step-by-step explanation:

The main advantage that Municipal Bonds usually carry with them is that they are tax-exempt. As no taxes are paid on them, there is no need to calculate an after-tax return because it is the same as a pre-tax return.

After-Tax return on Municipal Bond = 7%

The Corporate Bond is subject to tax based on the holder's tax bracket.

After-Tax Return on Corporate Bond = 8.4 % * ( 1 - 20%)

After-Tax Return on Corporate Bond = 6.72%

Considering taxes, the Municipal Bond is better.