A corporate bond currently yields 8.5%.Municipal bonds with the same risk,maturity,and liquidity currently yield 5.5%.At what tax rate would investors be indifferent between the two bonds?

Question

Quizplus · Accepted Answer

To determine the tax rate at which investors would be indifferent between the two bonds, we need to calculate the after-tax yield of the corporate bond and compare it to the yield of the municipal bond. Let's assume the investor is in the 35% tax bracket.

After-tax yield of corporate bond = 8.5% x (1 - 0.35) = 5.53%
Yield of municipal bond = 5.5%

Since the after-tax yield of the corporate bond at a 35% tax rate (5.53%) is greater than the yield of the municipal bond (5.5%), investors would prefer the corporate bond at this tax rate. Any tax rate above 35.29% would make the municipal bond a more attractive choice, and any rate below 35.29% would make the corporate bond a more attractive choice. Therefore, the answer is A) 35.29%.

A Corporate Bond Currently Yields 8