A 6.5 percent coupon bond issued by the State of California 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 26 percent marginal tax bracket?

Question

Quizplus · Accepted Answer

To find the coupon rate of a corporate bond that produces the same after-tax return as the municipal bond, we need to use the after-tax yield formula:
After-tax yield = pre-tax yield x (1 - marginal tax rate)

Let's first calculate the after-tax yield of the municipal bond:
After-tax yield = 6.5% x (1 - 0.26) = 4.81%

Now, we can use this after-tax yield and the formula above to solve for the coupon rate of the corporate bond:
4.81% = coupon rate x (1 - 0.26)
coupon rate = 6.51%

Therefore, the coupon rate on a corporate bond selling at $1,000 par value that would produce the same after-tax return as the municipal bond is 6.51%, which is closest to option C (8.78%).

A 65 Percent Coupon Bond Issued by the State of California