Question

An investment is in the 28% tax bracket and lives in a state with no income tax. He is trying to decide which of two bonds to purchase. One is a 7.5% corporate bond that is selling at par. The other is a municipal bond with a 5.25% coupon that is also selling at par. If all other features of these two bonds are comparable, which should the investor select? Why? Would your answer change if this were an in-state municipal bond and the investor lived in a place with high state income taxes? Explain.

Answer 1

Municipal bonds are the bonds that are issued by the a state for the purpose of collecting funds for capital expenditures. Whereas corporate bonds raised by a company to raise fiancé for their working.

As stated , the corporate bonds earn 7.5% interest whereas the municipal bonds earn 5.25% and the state has no income tax. In such scenario as the corporate bonds ahs higher rate of return ,these should be selected.

But, if the municipal bonds are issued in state and has higher income tax rate, then municipal bonds must be selected over the corporate bonds. Because, municipal bonds are exempt from from state income taxes, they are free from state income tax. This makes them very attractive to the people.