Question

Suppose that short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is-

a. Zero

b. 10%

c. 20%

d. 30%

Short answer

For tax bracket zero and10%, taxable bonds would give higher after yield.

For tax brackets 30% municipal bonds would give higher yield.

Step-by-step solution

Definition

The tax exempt bonds issued by state and local governments are called municipal bonds.

Explanation

With zero tax bracket, the after tax yield is the same as before tax-yield. With 10% tax bracket, the after-tax yield for the taxable bond would be4.5%. With 20% tax bracket, the after-tax yield for the taxable bond would be4 % which would be equal to that of the yield on the municipal bond.With 30% tax bracket, the after-tax yield for the taxable bond would be3.5 %

Therefore for tax bracket zero and10%, taxable bonds would give higher after yield. For 20% tax bracket, the municipal bond and taxable bond would be equal, while for tax brackets 30% municipal bonds would give higher yield.