Question

A municipal bond yields 6.75%. A corporate bond on comparable credit quality and maturity yields 9.0%. At what marginal tax rate would an investor be indifferent between the two bonds

Answer 1

Marginal tax = 25%

Step-by-step explanation:

To be indifferent between the bonds then return from both types of bond should be same. The municipal bond yields are tax free so tax can be imposed on the corporate bonds.

Thus, the (9 - 6.75) / 9 = 0.25 or 25%

So, a marginal tax of 25% should be imposed in order to be indifferent between the bonds.