Question

You are in the 32% federal tax bracket. You are offered a taxable bond with a yield of 8.0% and a municipal (muni) bond with a yield of 5.8%. What is the breakeven federal tax rate where you are indifferent with regard to purchasing the taxable bond or the municipal bond? Should you buy the taxable bond? A) 27.50% breakeven tax bracket; No, you should buy the muni bond B) 27.50% breakeven tax bracket; Yes, you should buy the taxable bond C) 29.80% breakeven tax bracket; No, you should buy the muni bond D) 29.80% breakeven tax bracket; Yes, you should buy the taxable bond E) 37.93% breakeven tax bracket; No, you should buy the muni bond F) 37.93% breakeven tax bracket; Yes, you should buy the taxable bond G) None of the above

Answer 1

Answer: A. 27.50% breakeven tax bracket; No, you should buy the muni bond

Explanation:

The breakeven federal tax rate where one is indifferent with regard to purchasing the taxable bond or the municipal bond will be calculated as:

= 1 - municipal bond yield/taxable bond yield

= 1 - (5.8% / 8%)

= 1 - (0.058 / 0.08)

= 1 - 0.725

= 0.275

=27.50%

Therefore, the answer will be A) 27.50% breakeven tax bracket; No, you should buy the municipal bond.