There are no asset prices given 7. Suppose that you are a saver with a choice of

Question

There are no asset prices given

7. Suppose that you are a saver with a choice of three financial assets that are identical in every way except their nominal interest rate and taxability. Calculate the after tax real yield for each of the following three assets and choose which of the three assets is the best option if inflation is expected to be 1.75% annually with a federal income tax rate of26%. Asset 1 : A corporate bond with an interest rate 7.5% in a state with an income tax rate of 4.5%. Asset 2: A Treasury bond with an interest rate 6.25% in a state income tax rate of 0%. Asset 3: A municipal bond with an interest rate 5.0% in a state with an income tax rate of 5.5%.

Explanation / Answer

Let Face Value of Bond be 100 For Corporate Bond of 7.5%, the interest receivable is 7.5 The federal tax is 26% Less: 1.95 State tax @ 4.5% Less: 0.3375 Net Yield 5.21% Treasury Bond @ 6.25% Interest receivable is 6.25 Federal Tax rate is 26% Less: 1.625 Net Yield: 4.63% Municipal Bond @ 5% 5 Federal tax is exempt State Tax @ 5.5% Less: 0.275 Net Yield 4.73% Since highest yield is available for corporate debt, so we should opt for that

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