Question

Consider the decision to purchase either a 5-year corporate bond or a 5-year municipal bond.
The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%.
The municipal bond has an 8.5% annual coupon and a par value of $1,000. It is currently yielding 7%.
Which of the two bonds would be more beneficial to you? Assume that your marginal tax rate is 35%.
Municipal Bond
Purchase Price
After-tax Coupon Payment
Par Value
Calculated YTM
Corporate Bond
Purchase Price
After-tax Coupon Payment
Par Value
Calculated YTM
Which of the two bonds would be more beneficial to you:
Why:

Answer 1

Municipal Bond
Purchase price	PV of coupons +PV of Face value at maturity
	ie.((1000*8.5%)*(1-1.07^-5)/0.07)+(1000/1.07^5)=
	1061.50
After-tax coupon payment	1000*8.5%=
	85
	(Coupons recd. On Munis are tax-exempt)
Par value	1000
Calculated YTM	1061.50=(85*(1-(1+r)^-5)/r)+(1000/(1+r)^5)=
	Solving for r, we get the YTM as
	7.00%

Corporate Bond
Purchase price	PV of coupons +PV of Face value at maturity
	ie.((1000*12%)*(1-1.115^-5)/0.115)+(1000/1.115^5)=
	1018.25
After-tax coupon payment	1000*12%*(1-35%)=
	78
Par value	1000
Calculated YTM	1018.25=(78*(1-(1+r)^-5)/r)+(1000/(1+r)^5)=
	Solving for r, we get the YTM as
	7.35%

Corporate bond will be more beneficial

as the YTM or IRR of the cash outflows & inflows from holding the bond for 5 years is more , with corporate bond than the municipal bonds