Question

After-tax Yield. You need to choose between investing in a one-year municipal bond with a 0.01 yield and a one-year corporate bond with an 0.09 yield. If your marginal federal income tax rate is 0.22 and no other differences exist between these two securities, which one would you invest in? For the answer, enter the after-tax yield that you will ultimately get once you choose the best bond. Enter the answer as a decimal using 4 decimals (e.g. 0.1234).

Answer 1

Sol:

Municipal Bond = 0.01 yield

Corporare Bond = 0.09 Yield

Tax = 0.22

Municipal bond has no marginal tax. So It will be = 0.01

Whereas Corporate bonds are subject to tax deduction. So it will be,

After tax yield = Rate × ( 1- tax)

= 0.09 × (1 - 0.22)

= 0.09 × 0.78

= 0.0702

So after tax yield of

Municipal Bond = 0.01

Corporate Bond = 0.0702

I will choose Corporate bond over Municipal bond because it has more rate of return than municipal bond.