Question

A municipal bond has a YTM of 5.01 percent while the YTM of a comparable taxable bond is 7.69 percent. What is the tax rate that will make an investor indifferent between the municipal bond and the taxable bond?​

Answer 1

Municipal bond doesn’t have tax liability; its income is exempted from tax. It makes the bond attractive and can issue at lower YTM compare to a taxable bond.

Required tax rate = 1 – (Municipal bond YTM / Taxable bond YTM)

                             = 1 – (5.01 / 7.69)

                             = 1 – 0.6515

                             = 0.3485

It should be multiplied by 100 to get the tax rate in percentage form. (0.3485 × 100 =) 34.85%.

Answer: The required tax rate is 34.85%.