Question

Your tax rate is 35%. Which of the following interest rates would you rather receive?

1.6% on municipal bonds

2% on Treasury bonds

Answer 1

Tax rate = 35%

- Interest rate on Municipal Bonds = 1.6%

Municipal Bonds are tax free which means that interest earned on Municipal bonds are exempt from taxes.

Thus, Interest rate earned on municipal bonds will be 1.6%

- Interest rate on Treasury Bonds = 2%

Treasury bonds are not tax exempt.

Thus, Interest rate earned on T- Bonds = Interest rate(1-Tax rate)

= 2%(1-0.35)

= 1.3%

Since, Municiapl Bonds provide higher after tax interest rate thus it is beneficial to invest in Municipal Bonds.

Hence, you would rather receive Interest rate on Municipal bonds.

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