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An investor purchases one municipal bond and one corporate bond that pay rates of return of 5% and 6.4%, respectively. If the investor is in the 15% tax bracket, his after-tax rates of return on the municipal and corporate bonds would be, respectively, _____..

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Answer:

The answer are:

  • Municipal bonds have an after tax rate of return of 5%
  • Corporate bonds have an after tax rate of return of 5.44%

Explanation:

Since earnings from municipal bonds are exempt from income taxes, their after tax rate of return is 5% (doesn't vary).

On the other hands earnings from corporate bonds are taxed by 15%. To calculate the after tax rate of return we multiply:

nominal rate of return x (1 - tax rate) = 6.4% x (1 - 15%) = 6.4% x 0.85 = 5.44%

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