Question

A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal taxes) is 39.00%. What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return

Answer 1

Answer:

The interest rate on corporate bond is 7.87 percent.

Explanation:

The yield on 7-year municipal bond = 4.8%

Given marginal tax rate = 39 percent  

Now calculate the interest rate on 7 year corporate bond that has equal risk.

Use the below formula. Here, yield from both type of bond is equated that is yield from corporate bond and yield from municipal bond because it is given that both gives same return after tax.

Interest rate on corporate bond × (1-tax rate) = Municipal bond yield

Interest rate on corporate bond × (1- 0.39) = 4.8$\text{Interest rate on corporate bond} = \frac{4.8}{0.61} = 7.87 \ percent$