Given the following information, which bond should a prudent investor choose? Justify your answer with mathematical...
- Given the following information, which bond should a prudent investor choose? Justify your answer with mathematical proof.
- At what marginal tax rate will an investor be indifferent between holding either security? Why?
MUNI yield-to-maturity = 1.4%
Corporate yield-to-maturity = 2.2%
Marginal tax bracket = 35%
Homework Answers
a. Munis is not taxed whereas Corporate bond is taxed
Hence after tax YTM of Corporate bond =2.2%*(1-Tax Rate)
=2.2%*(1-35%) =1.43%
Hence corporate bond is better than MUNIS bond because YTM of Munis
is lower.
b. Tax rate at which securities will be indifferent.
Munis YTM =Corporate bond YTM*(1-Tax Rate)
Tax Rate =1-Munis YTM/Corporate Bond YTM =1-1.4%/2.2% =36.36%
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