If an investor has a tax rate on interest income of 25% and the inflation rate is 4%,which bond has the lowest expected real after-tax interest rate?
A)A Treasury bond paying 9%
B)A corporate bond paying 8%
C)A Treasury bond paying 7%
D)A municipal bond paying 6%

Question

Quizplus · Accepted Answer

In order to calculate the expected real after-tax interest rate, we need to subtract the inflation rate and the tax rate from the bond's interest rate.

For option A, the expected real after-tax interest rate would be 9% - 4% - 25% = 2.25%.

For option B, the expected real after-tax interest rate would be 8% - 4% - 25% = 1.00%.

For option C, the expected real after-tax interest rate would be 7% - 4% - 25% = -0.25%. Note that this is a negative number, indicating that the investor would experience a loss in purchasing power.

For option D, the expected real after-tax interest rate would be 6% - 4% - 25% = -1.25%.

Therefore, option C, the Treasury bond paying 7%, has the lowest expected real after-tax interest rate.

If an Investor Has a Tax Rate on Interest Income