Question

5)A married couple from California is in the 31%Federal tax bracket and the 8%California tax bracket.They are considering a 5¼%Hawaii municipal bond (Federaltax-free), a 5% California bond (doubletax-free)or a 7¾% corporate bond (fully-taxable). Which bond offers the highest after-tax interest rate?

A California investor is in the 35% Federal tax bracket and the 9% California tax bracket. He has the choice of a 5% Oregon municipal bond (Federaltax-free), a 4¼% California bond(double tax-free) or a 7½% corporate bond(fully-taxable). Which bond offers the highest after-tax interest rate?

Using annual compounding, what price would you predict for a 20-year, 7% bond priced to yield 5%?

Using annual compounding, what price would you predict for a 10-year, 6% bond priced to yield 9%?

Answer 1

Answer to 1

Calculation of post tax returnd for all three bonds -

Hawaii, need to pay state atx, post tax return = 5.25 * (1-0.08) = 4.83%

California, no tax , so returm = 5%

Corporate bond, Post-tax return = 7.75 * (1 - 0.31 - 0.08) = 4.73%

So, Califirmia bond offer the best post tax returns.

Answert to 2.

Post tax return on Oregon municipal bond = 5 (1-0.09) = 4.55%

California bond return 9full tax free ) = 4.25%

Post tax return on Corporate bond = 7.5 (1-0.35-0.09) = 4.2%

Thus, Oregon municipal bond offer the best return.

Price would you predict for a 20-year, 7% bond priced to yield 5%

using formula -

Hence, Bond price = $ 1249

Price for a 10-year, 6% bond priced to yield 9%-

Bond price = $ 807