The Nominal Interest Rate on Taxable Bonds Is 8%,while on Municipal

question 53

Essay

The nominal interest rate on taxable bonds is 8%,while on municipal bonds (which aren't taxable)it is 5%.The expected inflation rate is 3% and the tax rate on interest income is 40%.Calculate the expected after-tax real interest rate on both bonds.Which would be the better investment? Now suppose the actual inflation rate turned out to be 6%.Which bond was the better investment? Would your answer change if inflation had turned out to be 0%?

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Definitions:

Shareholders

Individuals or entities that own shares in a corporation, giving them a part of the ownership of the company and potentially a claim on part of its assets and earnings.

Municipal Bond

A debt security issued by municipalities to finance their capital expenditures, typically tax-exempt for investors.

Government Bonds

Securities issued by a government to finance its expenditures, offering a fixed interest rate over a certain period.

Federal Income Tax

A charge imposed by the US federal government on the yearly income of persons, companies, trusts, and other entities.