Question

Suppose that your marginal federal income tax rate is 30%, the sum of your marginal state and local tax rates is 5%, and the yield on thirty-year U.S. Treasury bonds is 10%. You would be indifferent between buying a thirty-year Treasury bond and buying a thirty-year municipal bond issued within your state (ignoring differences in liquidity, risk, and costs of information) if the municipal bond has a yield ofA) 6.5%.
B) 7.0%.
C) 9.5%.
D) 10.0%.

Answer 1

Answer:

Option (B) is correct.

Explanation:

Given that,

Marginal federal income tax rate = 30%

Sum of your marginal state and local tax rates = 5%

Yield on thirty-year U.S. Treasury bonds = 10%

Municipal bond has a yield:

= U.S Treasury bonds × (1 - tax)

= 10% × (1 - 30%)

= (10 ÷ 100) × [1 - (30 ÷ 100)]

= (10 ÷ 100) × (70 ÷ 100 )

= (1 ÷ 10) × (7 ÷ 10 )

= (7 ÷ 100)

= 7%