A 9.0 percent coupon bond issued by the State of Iowa 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 30 percent marginal tax bracket?

Question

Quizplus · Accepted Answer

The after-tax return on the municipal bond is 9.0% since municipal bonds are tax-exempt. For the corporate bond, the after-tax return is the coupon rate multiplied by (1 - tax rate). To match the 9.0% return, the equation is: coupon rate * (1 - 0.30) = 9.0%. Solving for the coupon rate gives 12.86%.

A 90 Percent Coupon Bond Issued by the State of Iowa