Question

A tax-exempt municipal bond has a yield to maturity of 4.99%. An investor, who has a marginal tax rate of 30.00%, would prefer and an otherwise identical taxable corporate bond if it had a yield to maturity of more than ____%.

Answer 1

A tax exempt municipal bond yields a return of 4.99%,

The equivalent taxable interest rate for the investor will be :

R(te) = R(tf)/( 1 -tax rate),

where,

t= marginal tax rate

R( te) = equivalent tax free interest rate for the investor

R( tf) = return on tax free investment like municipal bond.

so, the figures will be:

4.99%/( 1- 0.3)

=7.1286%

The investor will prefer an identical corporate bond only if it offers an yield which is greater than 7.1286%.