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10 October, 04:03

A corporate bond currently yields 8.10%. Municipal bonds with the same risk, maturity, and liquidity currently yield 5.5%. At what tax rate would investors be indifferent between the two bonds?

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  1. 10 October, 05:21
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    At tax rate 32.1%, investors be indifferent between the two bonds

    Explanation:

    Yield after tax of corporate bond = 8.1% * (1 - tax rate)

    Investors would be indifferent between the two bonds when Yield after tax of corporate bond equals to yield of tax free municipal bonds.

    8.1% * (1 - tax rate) = 5.5%

    ⇔ 8.1% - 8.1% * tax rate = 5.5%

    Tax rate = (8.1% - 5.5%) / 8.1% = 32.1%
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