Question

Suppose your marginal federal income tax rate is 20%; the yield on 20 year U.S.Treasury bonds (T-Bond) is 10%. You would be indifferent between buying a 20 year T-Bond and a 20 year municipal bond, if the municipal bond has a yield of

Group of answer choices

6.5%.

10.0%.

7.0%.

8%.

Answer 1

Yield on 20 year US Treasury bonds = 10%

Marginal federal income tax rate = 20%

Yield on 20 year US Treasury bonds after tax = Yield on 20 year US Treasury bonds before tax (1 - tax rate)

Yield on 20 year US Treasury bonds after tax = 10 (1 - 0.20) = 8%

Thus,

The yield on 20 year US Treasury bonds after tax would be 8%.

The municipal bonds are exempted from federal income tax.

If municipal bonds alo pays 8% then a person would be indifferent between buying a 20 year T-Bond and a 20 year municipal bond.

Thus,

The correct answer is the option (d) [8%].

answered by: anonymous