You can invest in a fully taxable bond yielding 9% or in a municipal bond yielding 6%. Your marginal tax rate is 30%. In which bond should you invest, and what will be your real,
After-tax return on this investment if inflation is 3%?

Question

Quizplus · Accepted Answer

DTo determine the best investment option, we need to calculate the after-tax return for both bonds and then adjust for inflation. For the taxable bond:- The after-tax return is calculated as the yield (9%) minus the product of the yield and the tax rate (9% * 30% = 2.7%), which equals 6.3% (9% - 2.7% = 6.3%).- Adjusting for inflation (3%), the real after-tax return is 6.3% - 3% = 3.3%. However, due to rounding in the choices, the closest option is 3.2% in choice A.For the municipal bond:- The yield is 6%, and since municipal bonds are generally tax-exempt, we don't subtract any taxes for the purpose of this calculation.- Adjusting for inflation (3%), the real after-tax return is 6% - 3% = 3%. The closest option provided is 2.9% in choice D.Therefore, both A and D are correct based on the calculations, with A being the choice for the taxable bond and D for the municipal bond.

You Can Invest in a Fully Taxable Bond Yielding 9