The coupon rate on a municipal bond is 6.7%, and the rate on a corporate bond is 10%. Both bonds sell at par. The marginal tax rate at which an investor would be indifferent between the two bonds is

Question

The coupon rate on a municipal bond is 6.7%, and the rate on a corporate bond is 10%.  Both bonds sell at par.  The marginal tax rate at which an investor would be indifferent between the two bonds is

Quizplus · Accepted Answer

To be indifferent between the municipal bond and the corporate bond, the after-tax return on the corporate bond must equal the return on the municipal bond. The formula to find the marginal tax rate at which an investor would be indifferent is given by the return on the municipal bond divided by the return on the corporate bond. Thus, $ \frac{6.7\%}{10\%} = 0.67 $ or 67%. This means the investor would need to keep 67% of the corporate bond's return after taxes, implying a tax rate of $100\% - 67\% = 33\%$.

The Coupon Rate on a Municipal Bond Is 6