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?
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
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%.
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