Question

Laura just purchased a Florida general obligation bond with a yield of 4%. She is in the 35% federal bracket and 5% state bracket and is subject to the federal 3.8% NIIT. If Laura lives in Florida, what is the equivalent yield on a corporate bond? A) 4.219 B.)7.66% C.) 7.12% D.)6.67%

Answer 1

Solution:-

The Florida general obligation bond Laura has invested in is a tax free bond and carries a tax free interest of 4%. Now the yields of a corporate bonds are taxable, thus their equivalent yields would be equal to a rate that gives a post tax return of 4%. In other words, at this yield rate of a corporate bond, Laura would be indifferent to investing in either bonds as their post tax returns are same.

Equivalent yield on corporate bond= Yield on general obligation bond/(1- total tax rate)

Total tax rate= 35% + 5% + 3.8% = 43.8%

Equivalent yield on corporate bond= 4%*(1-43.8%)= 7.12%

Thus, the correct option is option C.