Question

A tax client has the opportunity to purchase a corporate bond with a yield to maturity of 6% OR a municipal bond with a yield to maturity of 4%. They are in the 33.33% marginal tax bracket. Please advise them of the tax implications of each investment choice.

Answer 1

The corporate bond has a yield to maturity of 6% while the municipal bond has a yield to maturity of 4%. The client would in general prefer the bond with the higher yield. But if the tax matters are taken into consideration then the client should be advised to take up the municipal bond as he/she would receive a tax exemption on it. But corporate bonds are taxable and so the income from the bond might be lost in the form of tax. Thus, municipal bond is preferred.