Question

A 5-year corporate bond yields 9.50%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the state tax rate is zero. At what federal tax rate are you indifferent between the two bonds? (Round your final answer to two decimal places.)

A. 37.89%
B. 35.37%
C. 38.53%
D. 36.95%
E. 31.58%

Answer 1

Answer:

31.58%

Explanation:

To work this out, then we must calculate the federal tax rate.

Given; Bond yield = 9.50%

           Risk yield = 6.50%

Risk yield = Bond yield * (1- Federal tax rate)

    6.50% =  9.50% * (1- Federal tax rate)

(1- Federal tax rate) = $\frac{6.50}{9.50}$

Federal tax rate = 1 - $\frac{6.50}{9.50}$

                       = 1 - 0.6842

                        = 0.3158 *100

                        = 31.58%

At a federal rate of 31.58%, I would be indifferent between the two.