Explain the following answer. 1.US municipal bonds are exempt from federal incom

Question

Explain the following answer.

1.US municipal bonds are exempt from federal income tax, and you are in 35% federal income tax bracket. If you have two alternatives to invest in Treasury bonds with interest rate of 3.50% and municipal bonds with interest rate of 2.75%. If there is no difference on earns on two bonds, what should interest rate on Treasury bonds be?

(A) 2.75% before tax.

(B) 2.275% after taxes.

(C) 4.231% before taxes.

(D) Both (A) and (C).

(E) None of the above.

AnswerC

2.

US municipal bonds are exempt from federal income tax, and you are in 39% federal income tax bracket. If you have two alternatives to invest in Treasury bonds with interest rate of 3.50% and municipal bonds with interest rate of 2.75%. Which is correct?

(A) you will purchase Treasury bonds.

(B) you earn 2.135% after taxes interest rates on Treasury bonds.

(C) you earn 1.6775% after taxes interest rates on Treasury bonds.

(D) Both (A) and (C).

(E) None of the above.

AnswerB

3.US municipal bonds are exempt from federal income tax, and you are in 39% federal income tax bracket. If you have two alternatives to invest in Treasury bonds with interest rate of 3.50% and municipal bonds with interest rate of 2.75%. If there is no difference on earns on two bonds, what should interest rate on Treasury bonds be?

(A) 2.75% before tax.

(B) 2.135% after taxes.

(C) 1.6775% before taxes.

(D) Both (A) and (C).

(E) None of the above.

AnswerC

Explanation / Answer

a) You earn 2.275% after taxes interest rates on Treasury bonds. This is due to the fact:

Let $100 be investment in bonds

Then, in that case, 100*103.5/100 = 103.5 (amount receivable before tax)

Then, the amount receivable after tax = 100 + (3.5*6.5/100) = 102.275

Therefore, the interest received after tax is 102.275 - 100 = 2.275

Hence, the after tax interest rate on bonds is 2.275/100 * 100 = 2.275%

Interest rate on Treasury bonds be 4.231% before taxes.

b) You earn 2.135% after taxes interest rates on Treasury bonds. This is due to:

Let $100 be investment in bonds

Then, 100*103.5/100 = 103.5 (amount recievable before tax)

Amount recievable after tax = 100 + (3.5*61/100) = 102.135

The interest recieved after tax is thus 102.135 - 100 = 2.135

Hence, the after tax interest rate on bonds is 2.135/100 * 100 = 2.135%

Therefore, Option B is correct.

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