Question

Tonya, who lives in California, inherited a $100,000 State of California bond in 2017. Her marginal Federal tax rate is 35%, and her marginal tax rate is 5%. The California bond pays 3.3% interest, which is not subject to California income tax/. She can purchase a corporate bond of comparable risk that will yield 5.2% or a U.S. government bond that pays a 4.6% interest. Which investment will provide the highest after-tax yield?

Answer 1

As the US government bond is free of any income/interest tax, so the yield on the government bond is 4.6%.

The corporate bond with the comparable risk paying interest 5.2% is subject income/interest tax at the rate of Federal marginal tax rate of 35%, so the after tax yield is 5.2% * (1 - 0.35) = 3.38%

The present investment in the California bond is providing yield of 3.3% which is free of any income/interest tax.

Thus, the decision of investment in the highest after-tax yield is "The investment in the US government bond which is providing 5.2% yield".

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