Question

A corporate bond currently yields 8.10%. 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?

Answer 1

Answer:

At tax rate 32.1%, investors be indifferent between the two bonds

Explanation:

Yield after tax of corporate bond = 8.1% * (1- tax rate)

Investors would be indifferent between the two bonds when Yield after tax of corporate bond equals to yield of tax free municipal bonds.

8.1% * (1- tax rate) = 5.5%

⇔ 8.1% - 8.1% * tax rate = 5.5%

Tax rate = (8.1% - 5.5%)/8.1% = 32.1%