A bank replaces 5-year corporate bonds with a coupon rate of 9.75 percent with 5-year municipal bonds with a coupon rate of 7 percent.The bank is in the 35 percent tax bracket and these bonds have the same default risk.What is the most likely reason the bank changed from the corporate to the municipal bonds?

Question

Quizplus · Accepted Answer

The most likely reason the bank changed from corporate to municipal bonds is to decrease their tax exposure. Municipal bonds offer tax-exempt interest income, which is advantageous for investors in high tax brackets, such as the bank in this scenario. By switching to municipal bonds, the bank can decrease their tax liability and potentially increase their after-tax return on investment.

A Bank Replaces 5-Year Corporate Bonds with a Coupon Rate