A 4.75 percent coupon bond issued by the State of Washington sells for $1,000. What coupon rate on a corporate bond selling at $1,000 par value would produce the same after-tax return to the investor as the municipal bond if the investor is in the 28 percent marginal tax bracket?

Question

Quizplus · Accepted Answer

To find the equivalent coupon rate on a corporate bond, we need to compute the after-tax yield on the municipal bond and set it equal to the pre-tax yield on the corporate bond. The after-tax yield on the municipal bond is: 
After-tax yield = pre-tax yield x (1 - marginal tax rate) 
= 4.75% x (1 - 0.28) 
= 3.42%

To find the pre-tax yield on the corporate bond, we can use the formula: 
Corporate bond yield = after-tax yield / (1 - marginal tax rate) 
= 3.42% / (1 - 0.28) 
= 4.75%

Therefore, the coupon rate on a corporate bond selling at $1,000 par value that would produce the same after-tax return to the investor as the municipal bond is 6.6% (closest to answer choice C).

A 475 Percent Coupon Bond Issued by the State of Washington