Asked by Gerson Torres on May 09, 2024
Verified
Assume a municipal bond is issued by the State of New York. Its yield is stated at 6%. A taxable corporate bond of equivalent quality is yielding 9%. You are in the 35% tax bracket and your son is in the 10% tax bracket. Which would be the correct investment strategy for both you and your son?
A) You and your son should acquire the municipal bond.
B) Your son should acquire the municipal bond, but you should acquire the corporate bond.
C) You and your son should acquire the corporate bond.
D) Your son should acquire the corporate bond, but you should acquire the municipal bond.
Municipal Bond
A debt security issued by a state, municipality, or county to finance its capital expenditures, often exempt from federal taxes and sometimes from state and local taxes.
Tax Bracket
The range of incomes taxed at a specified rate by the government, part of a progressive tax system where tax rates increase with income.
Corporate Bond
A debt security issued by a corporation to raise capital, obligating the issuer to pay interest and repay the principal at a specified date.
- Make informed decisions on investment strategies based on tax considerations.
Verified Answer
EA
Elmira AllabackMay 10, 2024
Final Answer :
D
Explanation :
To determine the best investment strategy, we calculate the tax-equivalent yield for the municipal bond for both tax brackets. For you, in the 35% tax bracket, the tax-equivalent yield is 6% / (1 - 0.35) = 9.23%. For your son, in the 10% tax bracket, it's 6% / (1 - 0.10) = 6.67%. Since the corporate bond yields 9%, it's better for your son (higher yield after tax), but the municipal bond is better for you (higher yield after considering your tax rate).
Learning Objectives
- Make informed decisions on investment strategies based on tax considerations.