If an investor is in the 22 percent income tax bracket and can earn 5 percent on a corporate bond, then 3 percent on a municipal bond is attractive.

Question

Quizplus · Accepted Answer

Municipal bonds are often tax-exempt, meaning the interest income is not subject to federal income taxes, and sometimes state and local taxes as well. However, to determine if a 3 percent municipal bond is more attractive than a 5 percent corporate bond for someone in the 22 percent tax bracket, you need to compare the after-tax return of the corporate bond to the tax-exempt return of the municipal bond. The after-tax return of the corporate bond is calculated as 5 percent * (1 - 0.22) = 3.9 percent. Since 3.9 percent is higher than 3 percent, the corporate bond is more attractive in this scenario, assuming the investor's primary concern is the yield.

If an Investor Is in the 22 Percent Income Tax