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Question 2-16I

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Essentials Of Investments
Found in: Page 50
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

Find the equivalent taxable yield of the municipal bond in Problem 14 for tax brackets of zero, 10%, 20%, and 30%.

With zero- taxable bonds,

With 10% tax bracket - taxable bonds

With 20% tax bracket – either one of these

With 30% tax bracket - municipal bonds

See the step by step solution

Step by Step Solution

Definition

The state and local governments issue municipal bonds. These bonds are tax exempt bonds.

Solution for scenario (i)

With zero tax bracket, the after tax yield is the same as before tax-yield that is 5%. This is greater than the yield on the municipal bond that is 4%. Therefore the correct answer is taxable bonds.

Solution for scenario (ii)

With 10% tax bracket, the after-tax yield for the taxable bond would be:

r(1 – t) rmuni

5%(1-10%) = r muni

=4.5%

This is greater than the yield on the municipal bond that is 4%. Therefore the correct answer is taxable bonds.

Solution for scenario (iii)

With 20% tax bracket, the after-tax yield for the taxable bond would be:

r(1-t) = r muni

5%(1-20%) = r muni

=4 %

This is equal to that of the yield on the municipal bond that is 4%. Therefore the correct answer is either one of these.

Solution for scenario (iv)

With 30% tax bracket, the after-tax yield for the taxable bond would be:

r(1 – t) rmuni

5%(1-30%) = r muni

= 3.5 %

This is less than that of the yield on the municipal bond that is 4%. Therefore the correct answer is municipal bonds.

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