The interest on some municipal bonds is tax free, in contrast to the interest on corporate bonds. If the current annual interest rates on otherwise similar(i.e., maturity, credit risk, liquidity) municipal and corporate bonds are 1.48\%1.48% and 1.80\%1.80%, respectively, what is the implied tax rate?
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The implied tax rate is 17.77%
Solution:
The corresponding tax rate estimate. We learn the following in the light of the knowledge from the question:
Municipal bond =1.48%
Corporate bond =1.80%
We are doing the following to determine the implicit tax rate,
Implicit tax rate = (0.018-0.0148)/0.018
= 0.0032/0.018
=0.177 or 17.77%
Therefore, The implied tax rate is 17.77%
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