A 7.0 percent coupon bond issued by the State of Tennessee 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 29 percent marginal tax bracket?

Question

Quizplus · Accepted Answer

To calculate the after-tax return on the municipal bond, we need to first calculate the after-tax coupon payment. 
After-tax coupon payment = Coupon payment * (1- Marginal tax rate) 
= 0.07 * (1-0.29) = 0.0497 or 4.97% 
Since the bond sells for $1,000, the after-tax yield is equal to the after-tax coupon payment, which is 4.97%. 
Now we need to find the coupon rate of the corporate bond that would give us the same after-tax yield. 
4.97% = Coupon rate * (1-0.29) 
Coupon rate = 0.07 / (1-0.29) = 0.0986 or 9.86% 
Therefore, the answer is C, 9.86 percent.

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