An investor is comparing a Corporate Bond yielding 6% and a Municipal Bond yielding 4%. The investor is in the 32% marginal tax bracket and subject to a 3.8% Net Investment Income Tax (NIIT). Which investment provides the higher after-tax yield?

Answer options:

Corporate Bond (4.08% after-tax)

Municipal Bond (4.00% after-tax)

Corporate Bond (3.85% after-tax)

Municipal Bond (2.56% after-tax)

How to approach this question

Calculate After-Tax Yield for Corp Bond: Yield * (1 - Tax Rate - NIIT). Compare to Muni Yield.

Full Answer

B.Municipal Bond (4.00% after-tax)✓ Correct

Corporate Bond Tax Rate = 32% + 3.8% = 35.8%. <br/>After-Tax Yield = 6% * (1 - 0.358) = 3.852%. <br/>Municipal Bond Yield = 4.0% (Exempt from regular tax and NIIT). <br/>4.0% > 3.852%. The Municipal Bond is better.

Common mistakes

Forgetting the NIIT or applying tax to the Muni bond.

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