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Assume that John's marginal tax rate is 17 percent. If a city of Austin bond pays 10.2 percent interest, what interest rate would a corporate bond have to offer for John to be indifferent between the two bonds

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Answer: 12.29%

Explanation:

Municipal bonds are tax exempt and so are attractive for this reason. If John is to be indifferent between the two, the corporate bond would have to offer a return that when adjusted for tax, will give the same return as the municipal bond.

Assume that return is x;

x * ( 1 - 17%) = 10.2%

0.83x = 10.2%

x = 10.2%/0.83

x = 12.29%

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