Question

You can invest in either corporate bonds which yield 4.21%, or municipal bonds (of equal risk) which yield 3.14%. Which investment should you choose for cases A and B? Tenore state income taxes A. Your personal tax rate is 35% B. Your personal tax rate is 15% Please show your calculation for both cases going from Monito Corporate bond, and once again from Corporate to Munibond equivalent interest rates, In other words, your calculations will cover two different situations for parts A & again for B: for a total of 4 different sets of calculations. Each set worth 25 points for a total of 10 points for this assignment

Answer 1

Answer-

Yield of corporate bond = 4.21 %
Yield of municipal bond = 3.14 %

Firstly we should know that the corporate bonds are subjected to the tax rate where as the municipal bonds are exempted from taxes ie. tax free both at federal and state level. However state income taxes are ignored as stated in the question.

A. Tax rate = 35 %

After tax for corporate bond
= 4.21 % x ( 1 - tax rate)
= 4.21% x ( 1 - 0.35)
= 4.21 x 0.65
= 2.736 %

After tax rate of municipal bond = 3.14 %
As the corporate bond interest rate post tax is less than ( 2.736 % ) the municipal bond interest rate ( 3.14%) therefore one should invest in municipal bond.

B.

Tax rate = 15 %

After tax for corporate bond
= 4.21 % x ( 1 - tax rate)
= 4.21% x ( 1 - 0.15)
= 4.21 x 0.85
= 3.578 %

After tax rate of municipal bond = 3.14 %
As the corporate bond interest rate post tax is more than ( 3.578 % ) the municipal bond interest rate ( 3.14%) therefore one should invest in corporate bond.