An investor purchases one municipal and one corporate bond that pay rates of return of 7.5% and 10.3%, respectively.If the investor is in the 25% marginal tax bracket, his or her after-tax rates of return on the municipal and corporate bonds would be ________ and ______, respectively.

Question

Quizplus · Accepted Answer

Municipal bond interest is typically tax-exempt, so the after-tax rate of return on the municipal bond will remain the same at 7.5%. However, for the corporate bond, the investor will have to pay taxes on the interest income. The after-tax rate of return on the corporate bond can be calculated as (1 – 0.25) x 10.3% = 7.73%. Therefore, the best choice would be to invest in both bonds, but the after-tax return on the municipal bond will be higher.

An Investor Purchases One Municipal and One Corporate Bond That