Question

You are an investor in the 37% marginal tax bracket. You are looking to invest some of your funds in a fixed income security. You see a Mecklenburg County municipal bond with a yield of 2.75%. The other bond you are considering is a corporate bond of equivalent credit yielding 4.50%. On the basis of taxable equivalent yield, which bond would you choose?

Answer 1

Post tax yield for a corporate bond = Pretax yield * (1 - Tax Rate)

Post tax yield for a corporate bond = 4.50% * (1 - 37%)

Post tax yield for a corporate bond = 2.835%

This is higher than yield of Municipal bond, which is tax-free.

Hence, choose Corporate Bond.